If you are a rental property investor shopping for a DSCR loan, you have probably come across the concept of a prepayment penalty. A pre payment penalty is a fee charged to the borrower for paying off the loan during a specified period of time.
Private lenders charge a pre-payment penalty to avoid a scenario where a loan is originated and then quickly paid off through a refinance or sale. In exchange for a competitive interest rate, the lender is looking to secure a longer duration of interest payments.
Let's take a moment to review common pre-payment penalty options and share insights to help you choose the best option for your next financing.
A 5-4-3-2-1 prepayment penalty, otherwise known as a 5 year stepdown prepayment penalty, charges a 5% fee on the outstanding principal loan balance if the loan is paid off in year 1, a 4% fee in year 2, a 3% fee in year 3, a 2% fee in year 4, and a 1% fee in year 5. If the loan is paid off in year 6, there will be no prepayment penalty.
The 5-4-3-2-1 prepayment penalty option carries a slightly lower interest rate than other pre payment penalty options, typically by 0.15% compared to the 3-2-1 prepayment penalty option, and is particularly popular among buy and hold rental investors during times of low interest rates.
A 3-2-1 prepayment penalty, otherwise known as a 3 year stepdown prepayment penalty, charges a 3% fee on the outstanding principal loan balance if the loan is paid off in year 1, a 2% fee in year 2, and a 1% fee in year 3. If the loan is paid off in year 4, there will be no prepayment penalty.
The 3-2-1 prepayment penalty option carries a slightly higher interest rate than the 5-4-3-2-1 option, typically 0.15%, and is particularly popular during times of elevated interest rates, because the borrower will be able to cost effectively refi after only a few years. The 3-2-1 pre payment penalty is the most popular option among clients of OfferMarket Capital.
A 3-0-0 prepayment penalty, charges a 3% fee on the outstanding principal loan balance if the loan is paid off in year 1, and no prepayment penalty thereafter. The 3-0-0 prepayment penalty option carries a higher interest rate than the 5-4-3-2-1 option, typically 0.4%, and is worth considering if you want to have a cost effective option to sell or refinance after the first year.
A 1-0-0 prepayment penalty, charges a low 1% fee on the outstanding principal loan balance if the loan is paid off in year 1, and no prepayment penalty thereafter. The 1-0-0 prepayment penalty option carries the highest interest rate compared to the 5-4-3-2-1 option, typically 0.65%. Like the 3-0-0 option, this is only worth considering if you expect to sell or refinance the property soon after the loan is originated. Many private lenders will require loan committee approval to offer this option, since the borrower may be trying to use this option instead of a short term bridge loan which typically carries a considerably higher interest rate.
Many borrowers do not realize that partial prepayment of principal during the prepayment penalty period are subjected to a penalty fee. So, if you have a 5-4-3-2-1 prepayment penalty clause, and you make a $1,000 additional payment towards your principal loan balance during year 1, you will be charged a 5% fee of $50.
While pre payment penalties are a standard term for DSCR loans, they are not common for short term fix and flip loans.
Our friendly and knowledgeable relationship managers are always happy to review loan requests and help you select the best pre payment penalty option for your real estate investing goals. For instant loan quotes and pre-approval, visit OfferMarket Capital.