DSCR Prepayment Penalties: Step-Downs, Buyouts and When They Matter
Most DSCR loans carry a prepayment penalty. It's rarely a problem if it matches your plan, and expensive if it doesn't. Here's how to read one.
Short answer
A prepayment penalty is a fee for paying off the loan early, usually a percentage of the balance that steps down each year. A common structure is 5-4-3-2-1: 5% in year one, falling to nothing after year five. Shorter penalties, or none, are often available in exchange for a higher rate.
Key points
- Common structures step down over three to five years.
- A shorter penalty usually costs a higher rate.
- Match the penalty to how long you'll hold.
How a step-down works
The penalty is a percentage of the balance you pay off, and it shrinks each year. Sell or refinance in year two of a 5-4-3-2-1 structure and you pay 4%; wait until year six and you pay nothing.
Deal sheet: 5-4-3-2-1 penalty on a $300,000 payoff, illustrative
| Penalty | Cost | |
|---|---|---|
| Year 1 | 5% | $15,000 |
| Year 2 | 4% | $12,000 |
| Year 3 | 3% | $9,000 |
| Year 4 | 2% | $6,000 |
| Year 5 | 1% | $3,000 |
| After year 5 | 0% | $0 |
Common structures
- 5-4-3-2-1: five years, stepping down 1% a year.
- 3-2-1: three years, a common middle ground.
- No penalty: available on some programs, usually at a higher rate.
Some loans use a flat percentage or a yield-maintenance formula instead, so read the note before you sign.
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Matching the penalty to your plan
- Holding five years or more: a longer penalty can buy a lower rate you'll actually benefit from.
- Planning to sell or refinance soon: a shorter penalty, or none, protects your exit.
- Waiting for rates to fall: a long penalty can wipe out the savings; see what half a point does to your payment.
Many lenders also allow partial paydowns each year without triggering the penalty, so ask.
Frequently asked questions
What is a 5-4-3-2-1 prepayment penalty?
It's a step-down penalty: 5% of the payoff balance in year one, 4% in year two and so on, reaching zero after year five.
Can I get a DSCR loan with no prepayment penalty?
Often, yes, but expect a higher rate. Whether it's worth it depends on how soon you might sell or refinance.
Does a prepayment penalty apply if I sell?
Usually. Selling pays off the loan, so the penalty applies unless the loan has passed its penalty period.
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