How do DSCR prepayment penalties work, and which one should I choose?

THE NUMBERS

ILLUSTRATIVE — published program floors, not a quote or a commitment to lend. Subject to underwriting, appraisal and final credit approval.

How is the penalty actually calculated?

A stepdown penalty is a percentage applied at payoff, taken from the year you are in. Pay off a 5-4-3-2-1 loan in month 20 and you are in year two, so the charge is 4%. Lenders differ on what that percentage is applied to — most use the outstanding principal balance at payoff, some use the original loan amount, and a few use a percentage of the interest that would have been earned. It is one line in your note and it changes the number materially, so read it before you sign rather than at payoff.

What triggers it — a sale, a refinance, or both?

Both, in most notes. The penalty attaches to early repayment of principal, whatever causes it: selling the property, refinancing with another lender, refinancing with the same lender, or paying it off with cash. Some lenders waive the penalty on a refinance kept in-house, some waive it on a bona fide sale to an unrelated buyer, and many waive neither. Those carve-outs are negotiable at term sheet stage and almost never afterwards, so if you know you may sell in year two, ask for the sale exception while the terms are still open.

Can I make extra payments without being penalised?

Usually some, and the allowance varies. A common structure permits partial prepayments up to a set share of the original balance each year — often in the region of ten to twenty percent — with the penalty applying only above that, and other notes charge from the first extra dollar. On a portfolio loan the equivalent mechanism is the release price: pay the agreed premium on the door you are selling and the rest of the pool carries on untouched. Confirm the exact allowance in your own note; do not rely on the market norm.

How do I choose between the structures?

Put a number on it. Work out what the shorter penalty costs in extra interest over the years you expect to hold, and set that against the penalty you would pay if you exit when you think you might. Long-term buy-and-hold files almost always take 5-4-3-2-1 at par, because the penalty is a fee they will never pay. Anyone with a live chance of selling or recapitalising in the first two or three years should price 3-2-1 or a one-year term. Buying the penalty away completely at 87.5 basis points is rarely worth it unless a specific exit is already scheduled.

Are prepayment penalties even allowed everywhere?

Not universally. Some states restrict or prohibit prepayment penalties on certain categories of mortgage loan, and the rules turn on the loan's purpose and the property type as much as on the state. Business-purpose loans on investment property are treated differently from consumer mortgages, which is one reason every Silt loan closes to an entity for a business purpose. Which structures are available on your specific deal in your specific state is a question for the term sheet — confirm it there, and with your attorney if the exit strategy depends on it.

Can I buy the rate down instead?

Yes, and it is a separate lever. Points buy rate at 0.25 of a point per 25 basis points, up to two points, which means you can hold the par 5-4-3-2-1 structure and still reduce the coupon. The two decisions are independent: the prepay term controls what an early exit costs, and points control what the money costs while you hold it. Investors who are certain of the hold usually buy rate down and keep the longest penalty; investors who are uncertain buy flexibility instead.

A worked example — 3-2-1 against a possible year-two sale

If you sell in year two, the shorter penalty is worth about $4,667 net. If you hold the full five years and never pay a penalty, that same choice cost you roughly $2,983 in extra interest over the period you held it. The penalty is calculated here on the outstanding balance; check whether your note uses the balance or the original amount. Illustrative only.

WHAT WE NEED FROM YOU

• Your intended hold period. Honestly stated — it drives the whole decision.
• Any planned exit. A scheduled sale, a 1031 window, or a partner buy-out.
• The rent and PITIA. Rate changes the payment, and the payment changes the DSCR.
• Entity documents. Articles, operating agreement and EIN letter.
• Two months of bank statements. Reserves are six months of PITIA.
• The property address. Availability of some structures depends on the state.

FREQUENT QUESTIONS

Does the penalty apply if I sell the property?

In most notes, yes — a sale repays the loan early like any other payoff. A sale carve-out can sometimes be negotiated at term sheet stage.

Is the penalty on the original loan amount or the current balance?

It varies by lender. Most apply it to the outstanding balance at payoff; some use the original amount. Read that line in your note.

Can I get a DSCR loan with no prepayment penalty at all?

Yes, at 87.5 basis points on the current sheet. It is the most expensive of the four choices and rarely the right one unless an exit is already scheduled.

Does the penalty run from closing or from the first payment?

From the note date in most documents, but that is a detail worth confirming in writing before you sign.

Can I pay the loan down without triggering it?

Often partially, up to whatever allowance your note grants. Above that allowance the penalty applies to the excess.

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