Quick answer
Business-purpose DSCR loans commonly carry a prepayment charge for an initial period of years. The most frequent forms are step-down schedules, such as a 5-4-3-2-1 or 3-2-1 schedule, fixed charges that stay level for the period, and yield maintenance-style formulas. The structure chosen often affects pricing, and options vary by lender, program and state law.
Overview
A prepayment charge compensates the holder of a loan for the income it loses when principal is returned early. Because DSCR loans are business-purpose credit on non-owner-occupied investment property, they are frequently originated with prepayment terms that would not appear on consumer mortgages. Investors evaluating a DSCR loan should treat the prepayment structure as a core economic term alongside the rate and fees.
Step-down schedules
A step-down schedule reduces the charge each year until it reaches zero. The schedule is usually written as a series of whole numbers, one per year, each representing the charge as a percentage of the amount prepaid. A 5-4-3-2-1 schedule, for example, sets the highest charge in year one and declines by one point each year until the charge disappears after year five. Shorter versions such as 3-2-1 or 2-1 follow the same logic over fewer years.
Fixed charges
A fixed structure applies the same charge throughout the prepayment period, then drops to zero. For example, a three-year fixed term applies one level charge in each of years one through three. Fixed structures are simpler to model but are more costly than a step-down in the later years of the period.
Yield maintenance-style structures
Yield maintenance, more common in commercial lending, calculates the charge so the holder receives roughly the same economic return as if the loan had run to the end of the protected period. The formula usually compares the note rate with a benchmark rate at the time of payoff. When benchmark rates have fallen, the charge can be substantial; when they have risen, it may be small. Some residential DSCR programs offer structures inspired by this approach, and terms differ widely.
Other variations
- Months-of-interest charges, which set the fee as a number of months of interest on the amount prepaid.
- Partial prepayment allowances that permit a portion of principal to be paid each year without a charge.
- No-prepayment options, typically available at different pricing.
Legal and program limits
Some states restrict or prohibit prepayment charges on certain loans, and some programs do not offer prepayment terms on particular property types or in particular states. A lender may also exclude a prepayment charge when payoff results from a casualty or condemnation. These limits vary by lender, program, investor guidelines and jurisdiction.
Choosing a structure
The right structure depends on the expected holding period. An investor planning a long hold may accept a longer prepayment period in exchange for better pricing, while one planning to sell, refinance or exchange the property sooner may prefer a short schedule or none at all. As a broker that shops financing from wholesale lenders, DSCRLoans.loan can compare how each available structure affects pricing across programs.
Common pitfalls
- Focusing on rate alone without modeling the cost of an early sale or refinance.
- Assuming a schedule counts from the first payment date when it counts from the note date, or the reverse.
- Overlooking that a refinance with the same lender may still trigger the charge.
- Misreading a fixed structure as a step-down.
Related terms
Prepayment terms interact with seasoning when planning a future cash-out refinance, and with vesting when a property is held in an entity that may later be sold or restructured.