Did you ever wonder why lenders push prepayment penalties?

[Dale Neibert]

Prepayment Penalties or PP

It’s not just a “gotcha.”

Most borrowers don’t realize this, but lenders pay a lot to get a loan done by the time you factor in sales, processing, underwriting, legal, commissions, and overhead. That might be 1-2% or call it $4-5K. On a long term with lower points (shouldn't be high points and high PP), they make that back on the "yield spread" which pays as you hold the loan each year, and your payment is slightly higher than the lenders cost of capital.

So, they need predictability on how long that capital stays deployed to make sure they make back their costs. If borrowers refinance or sell immediately, the lender loses money.

That’s why prepayment penalties (PPs) exist and are common in DSCR / non-QM loans.

Here’s what most investors miss: you can use this to your advantage.
Lenders will pay you (in rate) for giving them certainty.

• ~1 year PP → ~0.25–0.35% lower rate
• Longer PP → even better pricing

But context matters:

Taking a 5-year PP on a 3-year ARM is a mistake.

You’re locked in right when the rate starts floating.

That same issue doesn’t exist on a 30-year fixed.
The real move is simple: match the PP to your actual plan.
Ask yourself:

• Selling or refinancing in ~12 months? → then obviously keep PP short, but expect you may have to "buy it down" in points or in a higher rate so the lender knows they make more yield spread per year off the bat
• Holding 3–5 years+? → extend PP and take the lower pricing

Then optimize:

• Shorter PP = flexibility, higher cost
• Longer PP = less flexibility, better cash flow

You're actually on a team with lenders. You both want to do deals together. It's just good to understand their incentives, and then find the win-win.

Bottom line:
A prepayment penalty isn’t just a restriction, it’s a pricing lever. If your exit timeline is clear, you can trade restriction for a cheaper cost of capital. If it's shorter, you can pay a bit more now and make it work.

As you may have guessed, my team and I help folks fund deals like this all day. If you need help with some options or sanity checking current ones, let me know. Otherwise, excited for this new series of hopefully helpful and educational tidbits to get lenders and borrowers on the same page!

Next post:
Do you actually know the difference between a declining prepay vs. fixed prepay, and how that affects pricing? Most people don’t... and it matters more than you think