Many DSCR loans include a prepayment penalty, a fee charged if you pay the loan off early. It is one of the most overlooked terms in a rental loan, and it can affect when you sell or refinance. Understanding it up front helps you compare offers fairly.
Why lenders use prepayment penalties
Lenders fund these loans expecting to earn interest over a period of time. If the loan is paid off in the first few years, that income disappears. A prepayment penalty protects it. In return, a loan with a penalty can sometimes carry a lower interest rate than one without.
Common structures
- Step-down (for example 5-4-3-2-1). The penalty is a percentage of the balance that falls each year: 5 percent in year one, 4 in year two, and so on down to 1 percent in year five, then nothing.
- 3-2-1. The same idea over three years.
- Flat for a set period. A fixed percentage, such as a year or more of 1 percent, regardless of when in that window you pay off.
- No prepayment penalty. Offered on some programs, usually priced a bit higher in exchange for the flexibility.
Structures and percentages vary by lender and program, so treat these as examples rather than a promise of what is available.
What triggers it
Typically the penalty applies if you pay the loan off in full during the penalty period, whether through a sale or a refinance. Some programs also charge on large partial paydowns. Normal monthly payments never trigger it. Read the note carefully for exactly what counts.
A simple example
On a $300,000 balance with a 5-4-3-2-1 structure, paying off in year two would mean a 4 percent penalty, or $12,000. Paying off in year five would be 1 percent, or $3,000. The figures are hypothetical, but they show why your expected holding period matters.
How to plan around it
- Match the structure to your plan. If you expect to sell or refinance within a couple of years, a shorter or no-penalty option may cost less overall than a lower rate with a long penalty.
- Count it in your exit. Include the potential penalty when you project profit on a sale or the cost of a cash-out refinance.
- Ask what is negotiable. Sometimes you can trade a higher rate for a shorter penalty, or the reverse.
- Check your state. Rules on prepayment penalties differ by state and by whether the loan is to an entity, so the available options can change by location.
Compare offers on total cost
When comparing two quotes, look at rate, fees and prepayment terms together. The cheapest rate is not the cheapest loan if you plan to refinance in two years. The estimator is a good starting point, and a loan officer can walk through the options for your plan.