Prepayment Penalty
A fee charged if you pay off a loan early, common on DSCR rental loans. Often structured as a step-down (e.g., 5-4-3-2-1) over the first several years to protect the lender's expected yield.
A prepayment penalty (often called a prepay or PPP) is a fee a lender charges if you pay off a loan — by selling or refinancing — earlier than the loan terms anticipate. It's most common on long-term DSCR rental loans, and rare on short-term hard money.
Lenders price a 30-year DSCR loan expecting to earn interest for years. If a borrower refinances after 12 months, the lender's expected yield evaporates. The prepayment penalty compensates for that — and, importantly, it's part of why DSCR rates are competitive: the lender accepts a lower rate in exchange for some assurance the loan will stay on the books.
The step-down structure
Most DSCR prepayment penalties step down over the first several years. A common one is written as 5-4-3-2-1:
| Year paid off | Penalty (% of balance) |
|---|---|
| Year 1 | 5% |
| Year 2 | 4% |
| Year 3 | 3% |
| Year 4 | 2% |
| Year 5 | 1% |
| Year 6+ | 0% |
On a $300,000 balance, paying off in year 2 under a 5-4-3-2-1 costs 300,000 × 4% = $12,000.
Other structures exist — 3-2-1, flat (e.g., a fixed 3% for the first 3 years), or declining variants. Some lenders offer a "yield maintenance" prepay on larger loans.
Buying out the prepay
Many DSCR lenders let you reduce or eliminate the prepayment penalty in exchange for a higher interest rate or more points at closing. If you expect to sell or refinance soon, buying down the prepay can be worth it.
How to think about it
Match the prepay to your hold strategy:
- Long-term buy-and-hold: a standard step-down is fine — you won't trigger it.
- BRRRR or a likely near-term refinance: consider a shorter prepay (3-2-1) or buying it out, so a future cash-out refinance doesn't cost a large fee.
- Plan to sell within a year or two: a soft or bought-out prepay can save real money.
Always read the prepay terms alongside the rate — a slightly lower rate with a long, stiff prepay can cost more than a marginally higher rate with a soft one. State law also limits prepayment penalties on certain loans, but business-purpose investment loans generally permit them.
Frequently asked questions
What is a 5-4-3-2-1 prepayment penalty?
It's a step-down penalty for paying off a loan early: 5% of the balance in year 1, 4% in year 2, 3% in year 3, 2% in year 4, 1% in year 5, and 0% after that. It's one of the most common structures on DSCR rental loans.
Can I get a DSCR loan with no prepayment penalty?
Often yes — many lenders let you buy out the prepay for a higher rate or more points, and some markets and loan structures allow no-prepay options outright. It's a trade-off: a no-prepay loan usually carries a higher rate to compensate the lender.
Do hard money loans have prepayment penalties?
Rarely. Hard money and bridge loans are short-term and designed to be paid off quickly, so they usually have no prepay (some have a minimum-interest or minimum-term provision instead). Prepayment penalties are mainly a DSCR / long-term-loan feature.