DSCR Prepayment Penalties: The Number to Check Before You Sign
A prepayment penalty decides whether your exit is cheap or expensive, and it is set at closing. Here is how the structures work and which states restrict them.
Quick answer: DSCR prepayment periods run up to five years. The penalty is usually a fixed percentage of no less than 3%, or a declining structure that does not exceed 5% and does not drop below 3% during the first three years. Six states do not allow the penalty at all, and several more restrict it.
Investors spend weeks comparing rates and about four seconds on the prepayment term. That is backwards. The rate decides what you pay while you hold the loan. The prepayment penalty decides what it costs to leave it, and leaving is the part of the plan most investors actually execute.
What the penalty is
A prepayment penalty is a fee for paying the loan off early, usually triggered by a refinance or a sale inside the penalty window. On investor loans it exists because the lender priced the loan expecting to hold it for a period. Pay it off in year one and that assumption breaks, so the cost is charged back to you.
Two structures are common. A fixed percentage applies the same rate across the whole period. A declining structure steps down each year, which is why you hear investors talk about a 5-4-3-2-1. Acceptable structures are a fixed percentage of no less than 3%, or a declining structure that does not exceed 5% and does not fall below 3% in the first three years.
Where the state rules change it
The penalty is not uniform across the country, and the overlays are absolute rather than negotiable.
Prepayment penalties are not allowed at all in Alaska, Kansas, Michigan, Minnesota, New Mexico and Rhode Island.
In Illinois and New Jersey they are not allowed on loans vested to individuals. Vesting in an entity changes the answer, which is one of several reasons entity vesting comes up early on investor files.
In Pennsylvania they are not allowed on loan amounts under $319,777.
In Ohio, penalties on one to two unit properties cannot exceed 1% of the loan balance during the first five years.
Why it matters more than the rate
Run the arithmetic against your actual plan rather than against a spreadsheet that assumes you hold for thirty years.
If you are buying, renovating and refinancing, the penalty lands squarely on the refinance. A BRRRR strategy that works on paper can lose most of its margin to a penalty nobody read.
If you expect to sell inside five years, the penalty is part of your disposition cost, not a footnote.
If you are refinancing out of an existing DSCR loan, check the note you already have before you check anyone else’s rate sheet. Refinancing inside the window triggers the penalty, in many cases even when you refinance with the same lender.
The trade-off nobody explains
A longer prepayment period usually prices better. That is the deal being offered: you accept less flexibility and the rate improves. Taken deliberately on a property you intend to hold, that is a good trade. Taken by accident on a property you intend to flip, it is an expensive one.
The question is not which loan has no penalty. It is which penalty structure matches what you actually plan to do with the property.
Frequently asked questions
How long can a DSCR prepayment penalty run? Up to five years. The specific structures available are on the current rate sheet.
Which states do not allow one? Alaska, Kansas, Michigan, Minnesota, New Mexico and Rhode Island. Illinois and New Jersey do not allow them on loans vested to individuals.
Does refinancing with the same lender avoid it? Usually not. Refinancing inside the window commonly triggers the penalty regardless of who writes the new loan.
Can I buy the penalty down? Pricing and structure move together. Ask for the options side by side rather than assuming one is fixed.
Checking a Note Before You Refinance?
Send us the property and the existing note. We will check the penalty situation before anything else.
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