If there’s one feature of DSCR loans that surprises investors — especially those coming from conventional financing — it’s the prepayment penalty. Unlike the standard 30-year fixed mortgages most homeowners are familiar with, DSCR loans often include prepayment provisions that can cost you thousands if you sell or refinance too soon.
Understanding prepayment penalties before you close is essential. Signing a loan document with a penalty you didn’t know about — and then trying to sell or refinance within the penalty period — is an expensive and avoidable mistake.
What Is a Prepayment Penalty?
A prepayment penalty is a contractual fee charged to the borrower for paying off the loan early — either through a sale of the property or a refinance. It exists because DSCR lenders (and the investors in mortgage-backed securities who ultimately fund these loans) expect to earn a certain amount of interest income over the life of the loan. When you pay off early, they lose that expected income. The prepayment penalty is compensation for that shortfall.
Prepayment penalties are far more common on DSCR and investment property loans than on owner-occupied mortgages. In fact, prepayment penalties on primary residence mortgages are heavily restricted by federal law (the Dodd-Frank Act). Investment property loans face far fewer restrictions, which is why you’ll see them routinely on DSCR programs.
The Most Common DSCR Prepayment Structure: Step-Down Penalty
The most widely used prepayment structure on DSCR loans is the step-down penalty. Under this structure, the penalty amount decreases by a fixed percentage each year. The most common structure you’ll encounter is called a 5-4-3-2-1:
- Year 1: 5% of the outstanding loan balance
- Year 2: 4% of the outstanding loan balance
- Year 3: 3% of the outstanding loan balance
- Year 4: 2% of the outstanding loan balance