Why DSCR Loans Have Prepayment Penalties

DSCR lenders are typically non-bank private lenders or debt funds that fund loans with investor capital. When a borrower pays off a loan early, the lender loses the expected return on invested capital — the investor who funded the loan earns less interest than anticipated. Prepayment penalties compensate for this lost yield.

Conventional Fannie Mae and Freddie Mac loans do not include prepayment penalties (federal law prohibits them on conforming residential loans). But DSCR loans, as non-QM investment property products, are not subject to this restriction.

The Most Common Prepayment Penalty Structures

Step-Down Prepayment Penalty (Most Common)

The most common DSCR prepayment structure is a declining penalty tied to the loan amount. The classic structure is:

• Year 1: 5% of remaining loan balance
• Year 2: 4% of remaining loan balance
• Year 3: 3% of remaining loan balance
• Year 4: 2% of remaining loan balance
• Year 5: 1% of remaining loan balance
• Year 6+: No penalty

This is called a "5-4-3-2-1" prepayment penalty or "5-year step-down." Some programs use 3-year (3-2-1) or 2-year (2-1) structures.

Yield Maintenance (Less Common)

Some DSCR programs use yield maintenance, where the penalty is calculated based on the present value of lost interest over the remaining penalty period. This can be more expensive than a percentage-based step-down if market rates have dropped significantly since origination.

No Prepayment Penalty Programs

Some lenders offer zero-prepayment-penalty DSCR programs. These typically price 0.25-0.5% higher in rate than otherwise identical loans with a prepayment period. If you know you'll sell or refinance within 2-3 years, the rate premium may be less than the penalty you'd pay.

How to Calculate Your Prepayment Penalty

Example: You took a $400,000 DSCR loan in January 2025 with a 5-year step-down prepayment penalty. You sell the property in March 2027 (2 years and 2 months into the loan). By that point, your outstanding balance is approximately $387,000.

• Year 3 penalty rate: 3%
• Penalty amount: $387,000 × 3% =
  1,610

This comes out of your proceeds at closing — factor it into your return analysis when modeling an exit.

When Prepayment Penalties Don't Apply

Most DSCR prepayment structures do not apply when:

• The penalty period has fully expired (after 3 or 5 years, typically)
• The borrower sells to a third party and the buyer assumes the loan (rare, but some programs allow assumptions)
• The lender specifically waives the penalty (negotiate this upfront if you have leverage)

Note: refinancing a DSCR loan with the same lender (a "same-lender refi") often triggers the prepayment penalty just like a payoff would. Confirm this with your lender before refinancing.

Prepayment Penalty Strategy for Investors

• Buy-and-hold investors — A 5-year step-down is typically irrelevant. You're holding the asset 10+ years anyway.
• Value-add investors planning to refi in 2-3 years — Look for 3-year step-down or no-prepay options. The small rate premium is worth the flexibility.
• Bridge-to-DSCR strategies — If you're starting with a hard money loan and refinancing into a DSCR loan after stabilization, you'll hold the DSCR loan long-term — a 5-year step-down is fine.