Implied Call

An implied call is a right given to borrowers to pay back a loan at any time, even if it’s much earlier than the planned payback period. This term often applies to home loans, as most mortgages in the U.S. have an implied call.

The term “call” comes from the options market, where it refers to an agreement that gives the option buyer the right, but not the obligation to purchase an asset. Similarly, for borrowers, an implied call means they have the right, not the obligation to pay back the loan early.

The “implied” part of the definition means that it’s never explicitly stated, but it’s generally understood that borrowers can repay the loan sooner than expected.

The implied call is useful for borrowers. Say a couple with a mortgage hits the lottery, or suddenly comes into wealth. The implied call means these people can repay their mortgage early without any penalty. By doing so, the borrowers part with some of their wealth now, but will save money by skipping years of future interest payments on their principal.

The implied call also allows a borrower to go to another lender, or sometimes the same lender, take out a new mortgage at a lower rate, and use the proceeds to pay off the existing loan early. Refinancing can save borrowers thousands over the life of either a 15- or 30-year loan.

From the lender’s perspective, however, the implied call is not ideal. It represents a prepayment risk. While prepayment risk typically applies to bonds and mortgage-backed securities, it also is an issue for the mortgage lenders.

Say, for example, you pay off your 30-year mortgage in just 21 years. That means the bank will forego nine years of expected interest payments. The same holds true if a borrower refinances, especially with another lender, in which case the initial lender doesn’t just receive lower interest payments, it receives no payments; it just gets back the remaining principal.

Notably, an implied call also is included in most types of consumer loans, including auto, student, and personal loans. Lenders allow each to be repaid early without consequences.

Business investors also tend to take out mortgages on commercial properties, as well as shorter-term loans to finance purchases of capital equipment. As such, many business owners refinance longer-term business loans, either to one with a shorter term, or a shorter rate, or sometimes both.

The implied call also comes into play here. Medium-sized and large business make use of the implied call frequently, by evaluating their corporate balance sheets for business loans that can either be refinanced or paid off early. They do this with an eye toward improving the credit profile of the overall business.