Debt Service Coverage Ratio (DSCR) loans are popular with real estate investors. A key term to explain early is the DSCR prepayment penalty (PPP): a fee if the borrower pays off the loan, refinances, or prepays beyond an allowed amount during a set period. Pick a structure that matches the investor’s exit plan and desired pricing.
Key Takeaway: Choose the prepayment structure to fit the investor’s timeline. Longer or higher penalties usually price better; shorter or no‑PPP options trade a higher rate for flexibility.
What Brokers Must Know About DSCR Prepayment Penalties
Permitted structures at Lendz include:
(a) six months of interest on any prepayment amount exceeding 20% of the original principal balance (rolling 12 months);
(b) a fixed percentage of no less than 3%, with a 5% fixed prepayment penalty option typically offering the best pricing;
(c) a declining schedule that does not exceed 5% in any year and does not drop below 3% in the first three years.
How DSCR Prepayment Penalties Are Structured at Lendz Financial
Prepayment penalties apply only to investment properties and only within the defined prepay period, usually 1–5 years where allowed by state law. Choose a structure that fits the investor’s hold, sale, or refinance plan.
Think of a PPP as an “interest protection” window: better rate in exchange for a minimum stream of payments. If the investor exits early, the fee recoups part of that interest. Longer or steeper penalties can price better; lighter or no‑PPP options generally come with a rate add.
Six Months of Interest Method: Curtailment and Payoff Rules
Charges six months of interest on the portion of any prepayment that exceeds 20% of the original principal balance in a rolling 12‑month period. Applies to payoffs (sale/refi) and large principal curtailments during the prepay period.
Broker tip: Track the original balance and the rolling 12‑month allowance. Prepay up to 20% per rolling year without a fee; any excess triggers the charge.
Fixed-Percentage Penalties
A fixed percentage of at least 3% applies to the outstanding principal at payoff (and to curtailments as defined) during the prepay period. It’s simple to explain and forecast. While fixed penalties may start at 3%, a 5% fixed prepayment penalty will typically provide the strongest pricing available among the fixed-percentage options.
Brokers should weigh that pricing benefit against the borrower’s expected hold period and need for flexibility.
Declining Schedules: Caps and Approved Examples
Step‑downs must not exceed 5% in any year and should not drop below 3% in the first three years. Approved examples include 5%/4%/3%/3%/3% and 5%/4%/3%/2%/1% over a 3–5 year window.
Broker tip: If an exit is likely before the window ends, align it with a lower step.
Market Practice and Pricing Tradeoffs in Non-QM Wholesale Lending
Prepayment penalty terms can directly impact the rate and overall loan pricing. In general, stronger prepayment protection can improve loan pricing. For example, a 5% fixed prepayment penalty will typically price better than a lower fixed percentage, while lighter or no-PPP structures generally come with a pricing adjustment or higher rate.
Shopping structures can meaningfully change borrower cost and flexibility.
Scenario Walkthroughs: Calculate the Penalty and Set Expectations
- Refinance in Year 2 on a 5-4-3-2-1: A payoff in Year 2 triggers a 4% charge on the outstanding principal balance. If a sale or refinance is likely during that period, consider a shorter or lighter penalty schedule.
- Extra Principal in Year 1 Under the Six-Month Interest Method: The investor may allow the borrower to prepay up to 20% of the original balance within a rolling 12-month period without a fee. Any amount above that allowance may be charged six months of interest.
- Rate Versus Flexibility: Compare the higher payment created by the no-PPP rate premium with the potential penalty based on the borrower’s expected hold period. This helps determine which structure may be more cost-effective.
Broker Checklist: Match The Prepayment Structure to the Investor
- Exit plan: target refi/sale timing and likelihood of large curtailments.
- Pricing: accept a higher rate for flexibility, or a stronger price for a longer/steeper PPP. When comparing fixed-percentage options, include the 5% fixed structure, which will typically offer the best pricing.
- Trigger sensitivity: comfort with “hard” vs. “soft” terms and sale/refi scenarios.
- Documentation: verify state overlays, program matrix, and Business Purpose/Occupancy.
- Quote accuracy: show at least one alternative (lighter PPP vs. no‑PPP) with modeled cost.
DSCR Prepayment Penalty FAQs
Q: Do DSCR loans have a prepayment penalty?
A: Most include a penalty by default, but many lenders also offer a no‑PPP option for a higher rate. Always read the specific terms.
Q: What is the DSCR prepayment penalty and when does it apply?
A: It’s a fee if the borrower pays off, refinances, or prepays above allowed amounts during a set period (often 1–5 years). Structures include step‑downs, a fixed percentage, or a six‑months‑interest method. Many programs apply PPPs to both sale and refi; “soft” PPPs may waive the fee on sale.
Q: Can I get a DSCR loan without a prepayment penalty, and what’s the rate tradeoff?
A: Yes. Many programs allow a no‑PPP option for a rate add, commonly around 0.25%–0.50%. Compare the higher rate over time with the cost of a potential penalty.
Q: How are extra principal payments treated during the prepay period?
A: Under the six‑months‑interest method, borrowers can usually prepay up to 20% of the original balance in a rolling 12 months without a charge; any excess triggers the fee.
Q: Are prepayment penalties allowed in every state?
A: No. State rules can limit or prohibit certain terms. Always check state overlays and the program matrix before you quote.
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