Updated September 2, 2026
Quick answer
Most DSCR loans carry a prepayment penalty for the first three to five years, commonly as a step-down such as 5-4-3-2-1 — 5% of the balance repaid in year one, 4% in year two, and so on. Selling or refinancing inside that window triggers it. You can usually buy the penalty down or out by accepting a higher rate, which is worth doing only if you expect to exit early.
How a Step-Down Works
A step-down prepayment penalty charges a percentage of the balance you repay, falling each year until it disappears. The two structures you will see most often:
| Year | 5-4-3-2-1 | 3-2-1 | On a $225,000 balance (5-4-3-2-1) |
|---|---|---|---|
| 1 | 5% | 3% | $11,250 |
| 2 | 4% | 2% | $9,000 |
| 3 | 3% | 1% | $6,750 |
| 4 | 2% | — | $4,500 |
| 5 | 1% | — | $2,250 |
| 6+ | None | None | — |
The arithmetic is worth internalising. Selling in month 13 of a 5-4-3-2-1 on a $225,000 balance costs $9,000 — frequently more than the rate saving that bought the penalty in the first place.
The Other Structures
Step-downs are the most common but not the only shape:
- Flat penalty. A single percentage for the whole period, such as 3% for three years. Simpler, and worse than a step-down if you exit late in the window.
- Declining by month rather than year. Kinder to a borrower who exits mid-year.
- Yield maintenance. You make the lender whole on the interest they expected to earn. Far more expensive than a step-down when rates have fallen, and the cost is not knowable in advance.
- Interest guarantee. A minimum number of months of interest regardless of when you repay.
If a term sheet says yield maintenance rather than a percentage, ask for a worked figure at a couple of exit dates before signing. It is the one structure where borrowers routinely misjudge the cost by an order of magnitude.
What Triggers a Penalty
Anything that repays the loan early, which is a wider set than most people expect:
- Selling the property — the most common trigger
- Refinancing, including with the same lender in many cases
- A cash-out refinance that replaces the loan
- Paying the balance off from other funds
What usually does not trigger it: ordinary monthly payments, and additional principal payments up to whatever the note permits — often a percentage of the balance per year without charge. That allowance is worth reading, because it determines whether you can pay a loan down aggressively without paying for the privilege.
Some notes carve out an exemption for a sale to an unrelated third party. Some do not. It is a question worth asking rather than assuming.
Buying the Penalty Down
Most DSCR lenders will shorten or remove a prepayment penalty in exchange for a higher rate. The trade is straightforward to evaluate:
- Work out your realistic exit. Not your intended exit — your realistic one, including the possibility of selling sooner than planned.
- Price the penalty at that date. A percentage of the balance, from the schedule in the note.
- Price the rate difference over the same period. The extra interest you would pay to remove it.
- Compare the two numbers.
Buy-outs tend to be worth it when you genuinely expect to exit in the first two years — a flip taking longer than planned, or a property you intend to refinance once stabilised. They tend not to be worth it on a long-term hold, where you are paying a permanently higher rate to insure against an event you do not expect.
Where Investors Get Caught
Three patterns account for most of the unpleasant surprises:
- The BRRRR refinance. Buying, renovating and refinancing inside twelve months runs straight into year one of the penalty. If that is the plan, the penalty structure matters more than the rate. See DSCR as an exit from a flip.
- The unplanned sale. Life changes, a market turns, a partnership ends. The penalty does not care why.
- Rate-drop refinancing. Borrowers who took a high rate expecting to refinance when rates fell, without checking whether the note let them.
Read the prepayment clause before the rate. It is the term most likely to cost you real money and the one most often skimmed.
Frequently Asked Questions
What does 5-4-3-2-1 mean on a DSCR loan?
A step-down prepayment penalty. You pay 5% of the balance repaid if you pay off in year one, 4% in year two, 3% in year three, 2% in year four, 1% in year five, and nothing from year six. On a $225,000 balance that is $11,250 in year one falling to $2,250 in year five.
Do all DSCR loans have a prepayment penalty?
Most do, typically for three to five years, but not all. Lenders will generally shorten or remove one in exchange for a higher rate, so a no-penalty DSCR loan usually exists at a price rather than not existing.
Does selling the property trigger the prepayment penalty?
Usually yes — a sale repays the loan, which is exactly what the penalty is written for. Some notes carve out an exemption for a sale to an unrelated third party, so read the clause rather than assuming either way.
Can I make extra principal payments without a penalty?
Often, up to a limit. Many notes permit additional principal of a set percentage of the balance each year without charge, with the penalty applying only above that. The allowance is written into the note and is worth checking if you plan to pay down aggressively.
Is it worth paying a higher rate to remove the penalty?
Only if you realistically expect to exit early. Price the penalty at your likely exit date, price the rate difference over the same period, and compare. On a long-term hold you are usually paying a permanently higher rate to insure against something you do not expect to happen.
Sources & Further Reading
- CFPB Small Business Lending Research — Research and rulemaking on business credit disclosure, including how cost is presented to borrowers.
- FTC Business Credit and Finance Guidance — Federal Trade Commission guidance on fee disclosure and the warning signs of predatory business credit.
- Federal Reserve Senior Loan Officer Opinion Survey — Quarterly survey of bank lending standards, including commercial real estate. The public record of whether underwriting is tightening.
Figures above describe ranges commonly seen across DSCR lenders and reflect published guidance as of the date on this page. Confirm current terms with the cited source or your lender before acting.