DSCR Loan Prepayment Penalties

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DSCR Loan Prepayment Penalties

Gustavo Alvarez
Investor · Palm Beach County, FL · Member since 2021 · 14 posts · 10 votes

Hi there! I applied for a DSCR loan and the terms include vague language indicating they may be a penalty if paying the loan early. Is this common for these types of loans? Is there a typical minimum period where the penalty applies, like 3-5 years? Can this be negotiated?

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Robin SimonBusiness Member
Lender · Austin, TX · Member since 2022 · 5k+ posts · 4k+ votes
2y
Quote from @Gustavo Alvarez:

Hi there! I applied for a DSCR loan and the terms include vague language indicating they may be a penalty if paying the loan early. Is this common for these types of loans? Is there a typical minimum period where the penalty applies, like 3-5 years? Can this be negotiated?


Yes - generally prepayment penalties are common on DSCR Loans, but can vary and some DSCR Lenders will have DSCR options with no prepayment penalties (there are also a few states that preclude any prepayment penalties at all, even on investment properties - this includes Alaska, New Mexico, Kansas and some others).

There are two parts to a prepayment penalty - 1) How Long and 2) How Much

1) Generally it will be no more than 5 years for the length (i.e. if you prepay in the first five years of a thirty-year loan you are subject to a fee), but 4 or 3 or 2 or 1 year options are somewhat common. It is very very rare for a DSCR Loan to have a prepayment penalty duration more than 5 years

2) Generally this will range from 5% for the entire period, to a "descending penalty" structure which is very common - such as "5/4/3/2/1" where its 5% first year, 4% second year, 3% third year etc. There is also a prepayment structure that is equal to six months of interest (so half the rate) for about five years - this is more common for west coast DSCR lenders (sometimes called "Cali Style"

Generally OK to negotiate - but with no prepayment penalty, you are likely going to have a significantly higher rate or points at close

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  • Alex Hunt
    Lender · Member since 2022 · 441 posts · 134 votes
    2y

    Hey Gustavo, yes DSCR loans typically have a 5/4/3/2/1% prepay. Where it steps down 1% per year of the 1st 5 years of the loan. Some do straight 5% for 5 years
    You can ask if there is a 3/2/1% option you can buy down, I have even seen 0 prepay buydown but no ones bought it because it’s quite expensive. 

    4Reply
  • Ash Hegde
    Lender · Fort Lauderdale, FL (Lending in FL CT GA MI PA) · Member since 2022 · 470 posts · 349 votes
    2y

    For a DSCR loan, that is common. It's possible to find them without prepayment penalties, but the tradeoff will generally be a higher interest rate and/or additional fees (points).

    2Reply
  • Robin SimonBusiness Member
    Lender · Austin, TX · Member since 2022 · 5k+ posts · 4k+ votes
    2y
    Quote from @Gustavo Alvarez:

    Hi there! I applied for a DSCR loan and the terms include vague language indicating they may be a penalty if paying the loan early. Is this common for these types of loans? Is there a typical minimum period where the penalty applies, like 3-5 years? Can this be negotiated?


    Yes - generally prepayment penalties are common on DSCR Loans, but can vary and some DSCR Lenders will have DSCR options with no prepayment penalties (there are also a few states that preclude any prepayment penalties at all, even on investment properties - this includes Alaska, New Mexico, Kansas and some others).

    There are two parts to a prepayment penalty - 1) How Long and 2) How Much

    1) Generally it will be no more than 5 years for the length (i.e. if you prepay in the first five years of a thirty-year loan you are subject to a fee), but 4 or 3 or 2 or 1 year options are somewhat common. It is very very rare for a DSCR Loan to have a prepayment penalty duration more than 5 years

    2) Generally this will range from 5% for the entire period, to a "descending penalty" structure which is very common - such as "5/4/3/2/1" where its 5% first year, 4% second year, 3% third year etc. There is also a prepayment structure that is equal to six months of interest (so half the rate) for about five years - this is more common for west coast DSCR lenders (sometimes called "Cali Style"

    Generally OK to negotiate - but with no prepayment penalty, you are likely going to have a significantly higher rate or points at close

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    13Reply
  • AJ ExnerPro Member
    Lender · Springfield, MO · Member since 2023 · 652 posts · 314 votes
    2y
    Quote from @Gustavo Alvarez:

    Hi there! I applied for a DSCR loan and the terms include vague language indicating they may be a penalty if paying the loan early. Is this common for these types of loans? Is there a typical minimum period where the penalty applies, like 3-5 years? Can this be negotiated?


    Yes, they are typical, but each lender is going to vary considerably as to their PPP flexibility. For some groups, if they are aggressive in getting deals, they might offer discounts on their PPP plans to get more business. 

    It is worth having the conversation with them on the front end once you start talking with lenders.

    [email protected]417-427-2612
    1Reply
  • Devin PetersonBusiness Member
    Lender · Sarasota, FL · Member since 2022 · 2k+ posts · 664 votes
    2y
    Quote from @Gustavo Alvarez:

    Hi there! I applied for a DSCR loan and the terms include vague language indicating they may be a penalty if paying the loan early. Is this common for these types of loans? Is there a typical minimum period where the penalty applies, like 3-5 years? Can this be negotiated?


     Yes, its a norm. PPP - prepayment penalties can be anywhere between 1-6 years. You have the freedom to choose which PPP you so desire. Lenders have different overlays and structures when it comes to the "fee" penalty. Examples are as follows:

    5-4-3-2-1 (Stepdown in %)

    Flat 55555 (5% for all 5 years or 3 years (5-5-5)

    6 months of interest pmts on 80% of the loan balance (hybrid penalty)

    your PPP choice directly impacts your rate and DSCR so be sure to weigh out these factors altogether.

    Happy to help answer any other questions - good luck!

    [email protected]860-538-3672
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    0Reply
  • Jesse Byrer
    Lender · Chicago, IL · Member since 2008 · 54 posts · 34 votes
    2y

    @Gustavo Alvarez is see there are other lenders that have responded to you and have provide a general overview that I agree with so I won't repeat. I'm licensed in FL and offer DSCR loans and this is one of our niche products. My response will be tailored to what we do...

    Yes, we offer No PPP all the way to a 3 YR PPP.  As dicussed before, the tradeoff for No PPP is higher rates.  Our typical PPP is 6 months of interest, but we do offer a step down/tiered option as well (rates are not as competitive).  

    What I didn't see mentioned in prior comments (probably becaue it wasn't specifically asked) was paying point or "buying down" the rate.  When I've run into competition on these loans I've noticed most people charge points... which is an additional cost for the rate.  When doing the 3YR PPP I typically don't have points.  This varies based on credit and loan to value, but most of my client have not had to pay points.  Feel free to reach out if you want specifics, but if not best of luck in your journey!

    1Reply
  • Jalen ScottBusiness Member
    Metro Detroit · Member since 2024 · 8 posts · 2 votes
    2y
    Quote from @Gustavo Alvarez:

    Hi there! I applied for a DSCR loan and the terms include vague language indicating they may be a penalty if paying the loan early. Is this common for these types of loans? Is there a typical minimum period where the penalty applies, like 3-5 years? Can this be negotiated?


    some DSCR loans have pre payment penalties but certainly not all. Shop your mortgage. I work with 4 lenders and none of them have pre payment penalties on their DSCR.

    [email protected]517-214-2952
    0Reply
  • John Otradovec
    Lender · Springfield, MO · Member since 2024 · 46 posts · 20 votes
    2y
    Quote from @Gustavo Alvarez:

    Hi there! I applied for a DSCR loan and the terms include vague language indicating they may be a penalty if paying the loan early. Is this common for these types of loans? Is there a typical minimum period where the penalty applies, like 3-5 years? Can this be negotiated?


     Yes most are a 5/4/3/2/1 or 3/2/1.  I have a lender that will do a 1yr prepay for .125% added to rate which is amazing.  I am 20yr lender so let me know if you ever need help or have any questions.  

    Regards,

    John Otradovec

    1Reply
  • Eliott Elias
    Investor · Austin, TX · Member since 2021 · 9k+ posts · 5k+ votes
    2y

    Prepayment penalties usually are added to a loan to give you better terms, such as loan to value and interest-rate. There are lenders who have no prepayment penalties. The interest rates are most likely a lot higher.

    0Reply
  • Stacy RaskinBusiness Member
    Lender · Member since 2022 · 1k+ posts · 500 votes
    2y

    For most lenders, there are prepayment penalties from 1 year to 5 years. The shorter the prepayment term, the more impact it has on the rate. So a one year prepayment will drive the rate higher than a 5 year prepayment penalty. There are some states that don't allow prepayment penalties so the lender compensates with a higher rate. For some lenders, a 3 year prepay is neutral on the rate as as factor and a 5 year prepay is a 1/2 point reduction, a 4 year prepay is a .25 reduction and a 2 year prepay is a .25 add to the rate and a 1 year prepay is a .5 add to the rate. The language shouldn't be vague or you aren't talking to the right lender. You can decide which term you want. 

    More info on DSCR loans in case helpful:

    DSCR loans won't use your income to underwrite the loan.

    DSCR loans are based off of down payment, credit score and either actual or market rents so it helps to supercharge an investor's real estate goals and net worth.

    Here's a bit more in detail about how rates are calculated for DSCR loans:

    1. Credit score- the higher the best. 760+ generally gets best pricing for investment property loans with most lenders

    2. Loan to value ratio: The higher the loan to value ratio (LTV) is, pricing takes a hit. So your pricing will be higher for a 80% LTV loan than for a 60% LTV loan.

    3. Prepayment penalties- usually 1-5 year terms. The shorter the prepayment term has an impact on increasing the rate.

    4. Are you cash flowing the property? More on how that is calculated below. Is your DSCR ratio greater than 1-meaning are you cash flowing (according to the lender's criteria of mortgage, property taxes and insurance (and HOA) if applicable). Many lenders will not do a DSCR loan unless cash flowing. If they will do a loan with less than 1, the pricing takes a hit. This criteria is for 1-4 and 5-8 unit programs.

    I've included an example below to help illustrate this.

    So different lenders have different rates (which do vary even for DSCR loans) but these are factors they all consider.

    See example below:

    DSCR < 1

    Principal + Interest = $1,700

    Taxes = $350, Insurance = $100, Association Dues = $50

    Total PITIA = $2200

    Rent = $2000

    DSCR = Rent/PITIA = 2000/2200 = 0.91

    Since the DSCR is 0.91, we know the expenses are greater than the income of the property.

    DSCR >1

    Principal + Interest = $1,500

    Taxes = $250, Insurance = $100, Association Dues = $25

    Total PITIA = $1875 Rent = $2300

    DSCR = Rent/PITIA = $2300/$1875 = 1.23

    DSCR lenders generally let you vest either individually or as an LLC. It's a great way to increase your net worth and these loans can also be used to pull cash out of a property as it appreciates allowing you to reinvest money into new deals.

    Happy to connect to discuss further. 

    [email protected]818-770-0340
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    0Reply
  • Jay HurstBusiness Member
    Lender · Dallas, TX · Member since 2017 · 1k+ posts · 1k+ votes
    2y
    Quote from @Gustavo Alvarez:

    Hi there! I applied for a DSCR loan and the terms include vague language indicating they may be a penalty if paying the loan early. Is this common for these types of loans? Is there a typical minimum period where the penalty applies, like 3-5 years? Can this be negotiated?


    For lenders with NMLS numbers there are plenty of options without pre-payment penalties that will be in line in terms of rate/closing costs with those selling 3-5 year pre-payments. Pre-payment penalties can be very costly in a dropping interest rate environment. The vast majority of my DSCR loans have no pre-payment penalty.

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    0Reply
  • Matthew Mellon
    Rental Property Investor · Hopewell, VA · Member since 2017 · 21 posts · 7 votes
    2y

     I’ll also add that there are some instances where just making additional payments to pay down principle could trigger the due in full clause. Just double check those terms carefully. 

    1Reply
  • Jacob Sherman
    12 Penns Trail Suite 138 Newtown, PA 18940 · Member since 2023 · 1k+ posts · 319 votes
    2y

    Can definitely be negotiated . They are usually 1-5 years . 5 years you get the best pricing and 1 year worst pricing . It is common for all DSCR . For example in PA tho can't have a prepay if loan less than 312k so DSCR's are expensive . There are other states where 3 years is the max . Its a great product

    0Reply
  • Daniel Sperling
    Lender · Baltimore, MD · Member since 2019 · 37 posts · 34 votes
    2y

    Hi @Gustavo Alvarez, DSCR lender here. Most DSCR loans are 5-4-3-2-1 or 3-2-1 PPP. We also offer 2-1, 1-0 and no PPP at OfferMarket.

    No PPP => same rate as our 5-4-3-2-1 (best rate) + 1.125 points at settlement

    Rate for 3-2-1 vs. 5-4-3-2-1 is generally +0.125%.

    Many people do not realize that the PPP applies to partial payments (i.e. paying an extra $1,000 per month to pay the loan down faster will trigger the penalty).

    1Reply
  • Salvador Auciello
    Lender · Irvine CA · Member since 2019 · 71 posts · 22 votes
    2y

    Short and Sweet answer as a wholesale Lender.

    You can negotiate and tell the broker or lender what you want. If the broker or lender does not then find a broker or lender that will offer the terms you are looking for.

    Options are no pre-payment penalty to 5 years.

    Like some have noted there is a step down option or a hard option which adds to the pricing. 

    Now some lenders when you chose no ppp instead of adding the cost to the rate they add it as a discount option. 

    For example I have pricing today for multi family and DSCR loans where no prepay was just a .25% cost in points not on the rate.

    I would love to connect if you have any questions. 

    0Reply
  • Erik EstradaBusiness Member
    Lender · Member since 2022 · 6k+ posts · 1k+ votes
    2y
    Quote from @Gustavo Alvarez:

    Hi there! I applied for a DSCR loan and the terms include vague language indicating they may be a penalty if paying the loan early. Is this common for these types of loans? Is there a typical minimum period where the penalty applies, like 3-5 years? Can this be negotiated?


     Hi Gustavo, 

    You can reduce the PPP or buy it out entirely. 

    [email protected]818-269-7983
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  • Sasha MohammedPro Member
    Lender · Costa Mesa, CA · Member since 2018 · 337 posts · 245 votes
    2y

    i'll just add to what others have said - it's negotiable. but I would consider if the juice is worth the squeeze. 

    i just had this conversation with a client looking to borrow $100k. For him, he intends to keep the loan long term anyway, but the differential between a 5 year PPP and a 3 year PPP was .25% to rate. 

    On a "small" loan amount like his, he found it more beneficial to pay the extra .25% to rate to get the 3 year PPP. reason: it added only $17 per month to his payment every month; a small price to pay to open the door for refi or sale 2 years sooner. 

    On a larger loan size, this gap could be a substantial hit to your cash-flow. On a transaction with tight margins (barely debt-covering), this could be the difference between getting it done and not. 

    Just some food for thought as you're going through the motions :) it is absolutely negotiable, before you close the loan. 

    [email protected]949-351-1338
    0Reply
  • Luis Astudillo
    Member since 2024 · 23 posts · 8 votes
    2y
    Quote from @Gustavo Alvarez:

    Hi there! I applied for a DSCR loan and the terms include vague language indicating they may be a penalty if paying the loan early. Is this common for these types of loans? Is there a typical minimum period where the penalty applies, like 3-5 years? Can this be negotiated?


     Hey Gustavo, 

    DSCR loans do have pre pay penalties from 0 years to 5 years. With 0 prepay the interest will be much higher than if you were to choose a 5 year pre pay. Your loan officer should help you decide which pre pay option is best for you.

    0Reply
  • Tyler Warrick
    Lender · Chandler, AZ · Member since 2023 · 88 posts · 48 votes
    2y

    @Gustavo Alvarez Great question and yes this is normal. DSCR loans can range from 0-5 year PPP. The higher the PPP the better the rate and vice versa.

    I might be giving away a huge tip for other lenders, but this is my thought process when I purchase investment properties: I focus on cash flow, but only buy properties in areas that will appreciate (secondary goal for me). If a property appreciates at least 2-2.5% per year, I know that my PPP is essentially paid for if/when I refinance/sell. 


    How does this work? Most PPP are either 6 months of interest (typically on 80% of the original note balance), or 1/2/3/4/5% of the balance that is prepaid. When you factor it all out, it's about 2-2.5% of the property's value. So if appreciation is +2.5% then the market just paid for my PPP.

    0Reply
  • Austin ClarenceBusiness Member
    Lender · Phoenix, AZ · Member since 2023 · 135 posts · 31 votes
    2y

    There are a lot of DSCR options that do not have prepayment penalties. I personally would not settled for a DSCR loan in this market and put myself in a position where I am unable to refinance.

    [email protected]650-906-2376
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    0Reply
  • Tyler Warrick
    Lender · Chandler, AZ · Member since 2023 · 88 posts · 48 votes
    2y
    Quote from @Austin Clarence:

    There are a lot of DSCR options that do not have prepayment penalties. I personally would not settled for a DSCR loan in this market and put myself in a position where I am unable to refinance.


     Sounds like an agency guy to me ;)

    0Reply
  • Austin ClarenceBusiness Member
    Lender · Phoenix, AZ · Member since 2023 · 135 posts · 31 votes
    2y
    Quote from @Tyler Warrick:
    Quote from @Austin Clarence:

    There are a lot of DSCR options that do not have prepayment penalties. I personally would not settled for a DSCR loan in this market and put myself in a position where I am unable to refinance.


     Sounds like an agency guy to me ;)


    Not quite I love DSCR loans, there are a lot of DSCR options that do not have prepayment penalties. I meant to say I would not settle for a DSCR loan with a prepayment penalty* in this market. You are handcuffing yourself to the higher rate and will miss refinance opportunities.

    [email protected]650-906-2376
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  • Tyler Warrick
    Lender · Chandler, AZ · Member since 2023 · 88 posts · 48 votes
    2y
    Quote from @Austin Clarence:
    Quote from @Tyler Warrick:
    Quote from @Austin Clarence:

    There are a lot of DSCR options that do not have prepayment penalties. I personally would not settled for a DSCR loan in this market and put myself in a position where I am unable to refinance.


     Sounds like an agency guy to me ;)


    Not quite I love DSCR loans, there are a lot of DSCR options that do not have prepayment penalties. I meant to say I would not settle for a DSCR loan with a prepayment penalty* in this market. You are handcuffing yourself to the higher rate and will miss refinance opportunities.


     I'm just teasing you, brother. Gotta find some laughs on a Friday! Have you considered my post reply above yours? It's not for everyone, but definitely a different way to look at the money. 

    0Reply
  • Brayden Hrycko
    Lender · Allentown, PA · Member since 2023 · 207 posts · 38 votes
    2y

    Hello @Gustavo Alvarez,

    There are pre-payment penalties with DSCR loans because they are a commercial product. Typically 3-5 year terms.

    I do have a lender that I have used that will allow a pre-pay waiver if you refi with them when rates are better. They are pretty competitive on rates as well. 

    1Reply
  • Costin I.
    Rental Property Investor · Round Rock, TX · Member since 2016 · 1k+ posts · 971 votes
    2y

    Lenders, when we are talking about pre-payment, is that as in paying down the loan completely before the 5/4/3/2/1 period (zero balance), or any pre-payment (as in extra principal payments, monthly or periodically)?

    1Reply
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