DSCR Loan Prepayment Penalties Explained
- Jun 30
- 4 min read
One of the most overlooked features of DSCR loans — and the one that most commonly surprises investors — is the prepayment penalty.
Most DSCR loans come with one. And if you sell or refinance the property before the penalty period expires, it can cost thousands of dollars.
Quick Answer: Most DSCR loans include a prepayment penalty — typically a step-down penalty that decreases each year. A common structure is 5-4-3-2-1: 5% of the loan balance if you pay off in year 1, 4% in year 2, and so on. Prepayment penalties protect lenders from early loan payoff. They can be negotiated, waived for a higher rate, or priced into your exit strategy.
What Is a Prepayment Penalty?
A prepayment penalty is a fee charged by the lender if you pay off a loan before a specified period ends. It's designed to protect the lender's expected return — when they make a 30-year loan at a locked rate, they're pricing in years of interest income.
Prepayment penalties are standard on DSCR loans because they are non-QM (non-qualified mortgage) products. They are not allowed on conventional owner-occupied mortgages, but they are permitted on investment property loans.
Not all payoff events trigger a prepayment penalty. Typically, penalties apply to:
Selling the property
Refinancing the property
Paying the loan off in full with cash
Regular monthly payments, extra principal payments within limits, and payoff at natural loan maturity do not trigger penalties.
How DSCR Prepayment Penalties Are Structured
Step-Down Prepayment Penalty (Most Common)
The most common DSCR prepayment penalty is a step-down that decreases by 1% per year. The most typical structures are:
5-4-3-2-1 (5-year step-down):
Year 1: 5% of outstanding loan balance
Year 2: 4% of outstanding loan balance
Year 3: 3% of outstanding loan balance
Year 4: 2% of outstanding loan balance
Year 5: 1% of outstanding loan balance
Year 6+: No penalty
3-2-1 (3-year step-down):
Year 1: 3% of outstanding loan balance
Year 2: 2% of outstanding loan balance
Year 3: 1% of outstanding loan balance
Year 4+: No penalty
Example cost on a $250,000 loan with 5-4-3-2-1:
Sell in Year 1: $12,500 penalty
Sell in Year 3: $7,500 penalty
Sell in Year 6: $0 penalty
Have Questions About DSCR Loan Terms?
Review DSCR loan programs and prepayment penalty structures — transparent terms from day one.
How Prepayment Penalties Affect Your Investment Strategy
Long-term hold strategy (5+ years):
Prepayment penalties are largely irrelevant. You'll hold the property through the penalty period and sell or refinance without a fee.
BRRRR strategy (refinance within 1–2 years):
This is where prepayment penalties can be costly. A 5-4-3-2-1 penalty means paying 4–5% of the loan balance when you refinance. On a $200,000 loan, that's $8,000–$10,000. Consider a shorter penalty structure or no-prepay option if you plan to refinance quickly.
Value-add with near-term refinance:
If you're buying a property that needs light rehab and plan to refinance within 2–3 years once it's stabilized, factor the prepayment penalty into your numbers before you close. [LINK: investor-resources/refinance-investment-property-dscr-loan]
Can You Negotiate or Avoid a Prepayment Penalty?
Yes — to a degree.
Choose a Shorter Penalty Period
If a lender offers 5-4-3-2-1, ask if a 3-2-1 structure is available. Many lenders offer both options.
Waive the Prepayment Penalty for a Higher Rate
Some lenders allow you to take a higher interest rate in exchange for no prepayment penalty (or a shorter penalty period). Compare the two options numerically before deciding: the rate premium may be cheaper than the penalty if you sell within 2–3 years.
Some Lenders Have No Prepayment Penalties
A small number of DSCR lenders offer loans with no prepayment penalty — typically at a higher rate. These are worth considering for investors with a shorter-term plan.
How to Include Prepayment Penalties in Your Deal Analysis
Identify your intended hold period and most likely exit (sell, refi, or hold)
Ask the lender for the prepayment penalty structure before committing
Calculate the penalty at your expected exit date: Loan balance × penalty percentage
Add the penalty to your estimated closing costs when modeling your net proceeds
Bottom Line
Most DSCR loans include a step-down prepayment penalty (5-4-3-2-1 or 3-2-1 are most common)
The penalty applies when you sell, refinance, or pay off the loan in full — not for regular monthly payments
Long-term holders (5+ year strategy) are rarely affected; short-term exit plans require careful analysis
Penalties can often be negotiated or traded for a slightly higher rate — ask before you commit
Always model the prepayment penalty into your exit analysis for BRRRR deals or value-add plays
Frequently Asked Questions
Do all DSCR loans have prepayment penalties?
Most do, but not all. Prepayment penalties are standard on non-QM investment property loans because they are permitted on investment property loans (unlike owner-occupied mortgages). A small number of lenders offer DSCR loans with no prepayment penalty, typically at a higher interest rate.
What does a 5-4-3-2-1 prepayment penalty mean?
It means you pay a penalty equal to 5% of the outstanding loan balance if you pay off the loan in year 1, 4% in year 2, 3% in year 3, and so on. After year 5, there is no penalty. On a $250,000 loan, selling in year 2 would trigger a $10,000 prepayment penalty.
Does making extra principal payments trigger the prepayment penalty?
Generally no. Regular monthly payments and additional principal payments within normal limits do not trigger prepayment penalties. The penalty applies to full payoff events — selling the property, refinancing, or paying off the entire balance in cash. Check your specific loan terms to confirm.
Can I negotiate the prepayment penalty?
Yes, in many cases. Lenders often offer a choice between different penalty structures (5-4-3-2-1 vs. 3-2-1) or allow you to waive the penalty in exchange for a higher interest rate. If you have a shorter-term hold plan, it's worth asking your lender for a no-prepay option and calculating whether the rate premium is cheaper than the penalty would be.
Is a prepayment penalty tax-deductible on a rental property?
Prepayment penalties on investment property loans are generally deductible as a business expense in the year they are paid. Consult your CPA about your specific situation, as tax treatment depends on your overall tax situation and how the property is held.
Have Questions About DSCR Loan Terms?
Grafton Funding is transparent about prepayment penalty structures upfront. We'll walk you through exactly what your loan terms look like — including the prepayment penalty — so there are no surprises at closing or when you're ready to exit.
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