DSCR Loan Prepayment Penalties: What Your Exit Actually Costs
On our rates page we make a passing remark: on DSCR loans, the prepayment penalty is the trap that costs more than the rate difference you were optimising for. Several people have asked us to show the arithmetic. Here it is.
This is the clause that decides what your exit costs, and it is routinely skimmed past by borrowers who spent weeks negotiating an eighth of a point on the rate.
What the penalty actually is
A prepayment penalty is a fee for paying the loan off early — by selling, by refinancing, or by writing a cheque. On DSCR loans it comes in three shapes.
| Structure | How it works | Year-one cost |
|---|---|---|
| Step-down (5-4-3-2-1) | Penalty falls one point a year, gone after year five | 5% of the balance |
| Step-down with a floor (5-4-3-3-3) | Falls to 3% and stays there for the term | 5% of the balance |
| Flat | Same percentage whenever you exit inside the window | Often 5%, unchanging |
| Yield maintenance | You reimburse the lender’s lost interest, present-valued | Variable — see below |
Three-year terms typically run 5/4/3. The 5-4-3-2-1 step-down is the closest thing this market has to a standard, but it is not universal, and the softer-looking 5-4-3-3-3 is genuinely worse from year three onward — it never reaches zero inside the term.
Read the middle years, not the headline. Two structures that both open at 5% can differ by tens of thousands of dollars depending on when you actually leave.
It is charged on the balance, and the balance barely moves
The penalty is calculated on the outstanding principal at payoff, not the original loan amount. That sounds like it favours you. On a 30-year amortisation it does almost nothing.
A $400,000 loan at 7.25% has paid down to roughly $392,000 after two years. You have retired about 2% of the balance. The 4% penalty in year two is charged on essentially the whole loan.
Anyone telling you the penalty shrinks meaningfully as you pay down is describing a 15-year amortisation, not a 30.
The trade you are actually being offered
Here is the part that matters, and the part that is usually presented as a favour rather than a trade.
Lenders price the penalty into the rate. Accept a longer penalty and the rate comes down; ask for a shorter one, or none, and it goes up. Published guidance across the market puts that spread at roughly 0.25% to 0.50%, occasionally wider.
So the real question is not “do I want a prepayment penalty.” It is: does the rate discount, collected monthly, outweigh the penalty I might pay once?
Take a $400,000 loan on a 30-year amortisation, and two versions of it:
- Option A — 7.25%, with a 5-4-3-2-1 penalty. Payment $2,729/month.
- Option B — 7.625%, no penalty. Payment $2,831/month.
Option B costs you about $102 a month, or $1,230 a year, to keep your exit free.
| Exit in | Option A penalty | Option B extra interest paid | Cheaper |
|---|---|---|---|
| Year 1 | $19,800 | $1,230 | Option B |
| Year 2 | $15,700 | $2,460 | Option B |
| Year 3 | $11,600 | $3,690 | Option B |
| Year 4 | $7,650 | $4,920 | Option B |
| Year 5 | $3,780 | $6,150 | Option A |
| Year 7 | None | $8,610 | Option A |
The crossover sits between year four and year five. If there is any real chance you sell or refinance inside four years, the no-penalty premium pays for itself several times over. If you are genuinely holding the property long term, the discounted rate wins and keeps winning.
That is the whole decision, and it turns on one question you can answer honestly today: how long am I actually keeping this?
Illustrative arithmetic on stated assumptions, not a quote. Actual rates, structures and payments are set by the lender that underwrites your file and are subject to underwriting.
Yield maintenance is a different animal
Step-downs are predictable. Yield maintenance is not.
It calculates the present value of the interest the lender expected to earn and will now not earn, usually benchmarked against Treasury yields for the remaining term. The practical consequences are worth understanding before you agree to one.
When rates have fallen since you closed, yield maintenance is brutal. The lender cannot replace your rate in the market, so the shortfall it is reimbursing is large. Published guidance in 2026 puts step-down exits at roughly 1–5% of the balance, while yield maintenance can reach 10% or more.
When rates have risen, it can cost close to nothing. The lender can redeploy your money at a better rate than you were paying, so there is little lost yield to make whole.
Which means yield maintenance is a bet on the direction of rates over your hold period. If you would not knowingly take that bet, do not accept the clause without pricing it.
Some states restrict them — but check before relying on it
A handful of states prohibit prepayment penalties outright, and several more restrict them conditionally by loan size, rate or term. Alaska, Kansas, Minnesota, New Mexico and Rhode Island are commonly named in the first group; Illinois, Mississippi, New Jersey, Ohio and Pennsylvania in the second.
Do not treat that as a guarantee. Most of those statutes were written for consumer mortgage credit, and a business-purpose loan on non-owner-occupied investment property made to an entity is frequently treated differently. The protection you read about may not reach your loan.
Confirm the position for your state, your entity and your specific loan before you assume a clause is unenforceable. That is a question for a lawyer in the state, not for a lender’s sales desk.
What to ask before you sign
- Which structure is it? Get “5-4-3-2-1” or “5-4-3-3-3” in writing, not “standard step-down.”
- Is it charged on the outstanding balance or the original amount? Ask explicitly. Assume the balance.
- What does the no-penalty version cost? If nobody has quoted you one, you have not been shown the trade.
- Does a sale trigger it, or only a refinance? Some agreements exempt a bona fide sale. Many do not.
- Is there a partial-prepayment allowance? Some permit paying down a percentage each year penalty-free.
- If it is yield maintenance, ask for a worked example at two different rate scenarios. A lender who will not produce one is telling you something.
The pattern across all six: the penalty is negotiable far more often than borrowers assume, and it is almost never negotiated, because it is the last clause anybody reads.
Where this fits
If you are still deciding whether DSCR is the right instrument at all, the DSCR program page covers how these loans qualify on the property’s rent rather than your personal income, and DSCR or hard money works through which one suits which deal. Current market pricing across every program we place is on the rates page, sources and all.
If you already know the shape of your deal and want it placed with a lender whose structure fits your hold period, send it over. We are compensated by the lender when a transaction closes, so there is no cost to finding out where you stand.