INVESTOR GUIDE · PREPAYMENT PENALTIES
DSCR prepayment penalties
How to choose the right one. The longer the prepayment penalty, the lower the rate. The right choice depends on your exit strategy.
The short answer
- Every time you lengthen the prepayment penalty, the interest rate comes down.
- Match the prepay to your exit strategy: holding long term, take the longest; selling or refinancing soon, keep it short.
- Some states don’t allow a prepayment penalty at all, and others, like Pennsylvania and Maryland, limit them. Know the states you’re investing in, and know that lenders read those rules differently.
HOW IT WORKS
Longer prepay, lower rate
A prepayment penalty is a charge if you pay the loan off early, by selling or refinancing within the penalty period. Lenders price it in: every time you increase the prepayment penalty, the interest rate comes down.
YOUR OPTIONS
DSCR prepayment penalty options
- 5-year step-down: 5%, 4%, 3%, 2%, 1%. The penalty drops 1% each year.
- 5-year flat: the same penalty for all five years.
- Short-term step-down: 3-year at 3%, 2%, 1%.
- Short-term fixed: 3-year at 5%, 5%, 5%. No step-down.
- 1- or 2-year terms are also available.
- No prepayment penalty. Don’t mistake it for a gift. With no prepay, you either bought it out or took a higher rate. Nothing comes for free.
As you can see, there are a lot of variables, so know what you’re agreeing to. Talk them through with us. The right one matches your exit strategy and gets you the best rate.
MATCH IT TO YOUR EXIT STRATEGY
Choose your exit strategy first
Holding for the long term? If you just rehabbed the property and it debt services, the odds you’ll sell or refinance soon aren’t very good. Take the longest prepayment penalty you can and the lower rate that comes with it.
Planning to sell or refinance? Keep the prepayment penalty short, so you don’t get hit with a cost you weren’t prepared for in the next 12 to 24 months.
Thinking you’ll refinance later for a lower rate? On larger loan amounts, that can make sense. On loans of $200,000 and below, it typically doesn’t. By the time you pay closing costs again, after carrying a higher rate for the first year or two, the math rarely works. And your amortization starts over: in the first five years of a loan you pay mostly interest. When you finally reach year five and start to see the principal come down, do you really want to start all over again? On smaller loans, the answer is usually no.
STATE RULES
Your state may make the choice for you
Prepayment penalties depend on what your state allows. Some states don’t allow a prepayment penalty at all, and others, like Pennsylvania and Maryland, limit them. Know the states you’re investing in and their policies, and if you don’t, reach out and we’ll tell you.
A special note: lenders don’t all read state rules the same way. Some will allow a prepayment penalty where others won’t, which makes choosing the lender based on how it reads your state’s prepayment rules even more important. Entity matters too: depending on the lender, a state may allow a prepayment penalty when you close in an LLC that it wouldn’t allow in your personal name. See closing your DSCR loan in an LLC. We know them all.
STRAIGHT ANSWERS
Prepayment penalty questions
Does a longer prepayment penalty lower my DSCR rate?
Yes. Each step longer on the prepayment penalty brings the interest rate down.
How do I choose a prepayment penalty?
Match it to your exit strategy. Holding long term, take the longest you can. Selling or refinancing in the next year or two, keep it short.
Do all states allow prepayment penalties on DSCR loans?
No. Some states, including Pennsylvania and Maryland, limit prepayment penalties, and lenders don’t all read state rules the same way.
What prepayment penalty options are there on a DSCR loan?
Common options include a 5-year flat penalty, a 5-year step-down, 1-, 2- or 3-year terms with a step-down or fixed penalty, and no prepayment penalty. No prepay isn’t free: you either buy it out or take a higher rate. The right one matches your exit strategy and gets you the best rate.
Does it make sense to refinance a DSCR loan for a lower rate?
On larger loan amounts, it can. On loans of $200,000 and below, it usually doesn’t: you pay closing costs again, and your amortization starts over, so you go back to paying mostly interest.
KEEP READING
DSCR KINGS · INVESTOR FINANCING
Pick the prepay that fits your plan
Tell us your exit strategy. We’ll show you the rate at each prepayment option.
Business-purpose loans for investment properties only; not for owner-occupied homes. Lending guidelines, leverage and loan programs vary by lender and by state and are subject to change. Terms and approval depend on the property, the borrower’s credit and capital-partner guidelines and are not guaranteed. Examples are for illustration only.
