Prepayment Penalty

A prepayment penalty is a fee charged when a borrower pays off all or a large part of a loan before an agreed date. Most DSCR loans have one, often a step-down such as 5-4-3-2-1, meaning 5% of the balance in year one falling to 1% in year five.

Lenders price the penalty into the rate. A longer penalty period usually buys a lower rate, which lowers the payment and raises the ratio. A loan with no penalty costs more in rate and gives a lower DSCR on the same rent.

The penalty matters when you plan to sell or refinance. A 5% penalty on the site example's $375,000 balance is $18,750 in the first year. If a refinance or sale is likely within a few years, a shorter penalty and a slightly higher rate can cost less overall, as long as the ratio still clears the lender's minimum at that rate.

On a DSCR loan the penalty is normally a step-down across the first three to five years, charged as a percentage of the balance you pay off. On the site example's $375,000 balance, a 5-4-3-2-1 schedule costs $18,750 in year one and $3,750 in year five.

Year by year on $375,000: $18,750 at 5%, $15,000 at 4%, $11,250 at 3%, $7,500 at 2%, $3,750 at 1%. A flat 3% penalty on the same balance costs $11,250 at any point inside the term, so it beats the step-down only on an exit in the first two years.