DSCR prepayment penalty: how it works and what it costs

A DSCR prepayment penalty is a fee you owe if you pay the loan off early, by selling or refinancing, within a set window, commonly the first one to five years. The most common shape is a step-down such as 5-4-3-2-1: 5% of the balance you pay off in year one, 4% in year two, down to 1% in year five, and nothing after that. A longer penalty buys a lower rate; a shorter one, or none, costs more rate.

What a prepayment penalty is, and why DSCR loans have one

A prepayment penalty is a charge for paying a mortgage off ahead of schedule, usually by selling the property or refinancing it, and sometimes for a large lump-sum paydown. The investors who buy DSCR loans pay for years of expected interest. If you refinance in month ten, they lose that interest and have to reinvest at whatever rates are then available, so they ask for a fee if you leave early, and they price the loan lower in return.

Home loans are treated differently. Under Regulation Z, most consumer mortgages may carry a prepayment penalty only if they are fixed-rate qualified mortgages that are not higher-priced, and even then the penalty is capped at 2% of the amount prepaid in the first two years and 1% in the third, with none after three years. The lender also has to offer you an alternative loan without one. A DSCR loan on a rental you do not live in is business-purpose credit, exempt from Regulation Z, so none of those limits applies. That is why a five-year penalty is ordinary on a DSCR loan and unusual on a home.

The common structures

Structure	How it works	Paying off the example loan in year 2 ($295,772 balance)
Step-down 5-4-3-2-1	5% of the amount prepaid in year 1, falling one point a year to 1% in year 5	4% = $11,831
Step-down 3-2-1	Three years: 3%, then 2%, then 1%	2% = $5,915
Flat percentage	The same percentage throughout the window, such as 3% for three years	3% = $8,873
Six months' interest	Six months of interest on the amount prepaid above 20% of the original loan	($295,772 minus $60,000) × 7.50% ÷ 2 = $8,841
Yield maintenance	The lender's lost interest compared with Treasury yields	Depends on rates; often the largest
Defeasance	You buy Treasury bonds to replace the loan's payments	Mostly commercial loans
Lockout	No prepayment allowed at all for a period	Rare on DSCR loans

Variants are common: 5-5-5-5-5 (a flat 5% for five years), 3-3-3, 2-1, a single year at 1%, or a step-down that stops at a floor. On a DSCR loan the step-down and the flat percentage are the two you will see most.

What a 5-4-3-2-1 penalty costs, year by year

The example rental's $300,000 loan with a 5-4-3-2-1 penalty

The loan: $300,000, 30-year fixed at 7.50% (an example rate), a 5-4-3-2-1 step-down counted from the note date. If you pay it off in the middle of each year:

Payoff month	Balance	Penalty rate	Penalty
6 (year 1)	$298,643	5%	$14,932
18 (year 2)	$295,772	4%	$11,831
30 (year 3)	$292,679	3%	$8,780
42 (year 4)	$289,345	2%	$5,787
54 (year 5)	$285,752	1%	$2,858
61 or later	$283,529	None	$0

Waiting one month past the end of a year can save a full point: paying off in month 60 costs 1%, in month 61 nothing.

Choosing a length: the trade between penalty and rate

Lenders price each prepayment option on the same file. A shorter penalty commonly costs about 0.25% to 0.75% more in rate; removing it costs more again. The right choice depends on when you expect to sell or refinance.

Three versions of the same loan

The same $300,000, 30-year loan with three prepayment options. The rates are examples, a quarter point apart:

Option	Rate	Monthly principal and interest
A: 5-4-3-2-1	7.50%	$2,097.64
B: 3-2-1	7.75%	$2,149.24
C: No penalty	8.00%	$2,201.29

The total cost of each, counted as interest paid plus any penalty, by when you pay the loan off:

Payoff	A	B	C	Cheapest
Month 18	$45,361	$40,578	$35,787	C
Month 30	$64,388	$60,423	$59,378	C
Month 42	$83,233	$80,090	$82,735	B
Month 54	$101,882	$102,430	$105,838	A
Month 66	$120,325	$124,493	$128,665	A
Month 120	$212,102	$219,708	$227,329	A

With these prices: if you exit within three years, pay for no penalty; in year four, the three-year step-down is cheapest; from year five on, the five-year penalty's lower rate wins, by about $15,000 over ten years against no penalty.

If the lender's spread between options is wider than a quarter point, the longer penalty wins sooner; if it is narrower, later. Ask for every option on the same term sheet and run your own exit dates through the same table.

Matching the penalty to your plan

Buy and hold for five years or more: take the longest penalty and the lowest rate.
BRRRR or a planned refinance: match the window to the refinance date. The BRRRR method times the refinance step.
A planned cash-out: a cash-out inside the window pays the penalty out of your proceeds. DSCR cash-out refinance shows the math.
A sale or 1031 exchange within two or three years: a sale triggers the penalty like a refinance does, so price it in or choose a short one. 1031 exchange rules covers the timeline on the sale side.
Hoping to refinance if rates fall: the penalty eats part of the saving. Add it to the new loan's costs before you count on it.

The rate side of this trade, and how points compare with a longer penalty as a way to buy the rate down, is in DSCR loan rates.

Yield maintenance, explained

Yield maintenance makes the loan's investors whole for the interest they lose when you prepay. Roughly, it is the present value of the difference between your note rate and a Treasury yield of similar term, applied to your balance for the rest of the penalty period. It is standard on commercial and larger portfolio loans and uncommon on one to four unit DSCR loans.

As a simplified example: a $294,254 balance at the end of year two, a 7.50% note, a 4.50% Treasury yield and three years left in a five-year window. The 3% gap on that balance is about $735.64 a month; over 36 months, discounted at 4.50%, that is about $24,730. The same payoff on a 5-4-3-2-1 step-down would cost 3% of the balance, about $8,828. When rates fall, yield maintenance gets expensive; when Treasury yields rise above your note rate, it shrinks toward its floor, often 1%.

Which states restrict prepayment penalties?

There is no single list. State rules differ by loan type, lien position, property type, loan size and whether the borrower is an individual or an entity, and they change. Some states bar penalties on residential loans to individuals but allow them when an LLC borrows; others cap the amount or the length. Lenders turn all this into a state matrix, and in a restricted state a loan commonly comes with no penalty at a higher rate, with a shorter or capped penalty, or only to an entity borrower.

As of 2026, states that commonly appear on lenders' no-penalty or restricted lists include Alaska, Michigan, Minnesota and New Mexico. Others, such as Illinois, Kansas, Mississippi, Ohio and Vermont, appear on some lists and not others, and in New Jersey some lenders allow a penalty only when the borrower is an entity. Treat this as a reason to ask, not as legal advice: the term sheet for your property is the answer.

What counts as a prepayment

A sale, which pays the loan off at closing. Most DSCR penalties are "hard": they apply to a sale and a refinance alike. A "soft" penalty, charged on a refinance but not a sale, is rare on DSCR loans.
A refinance, with any lender, including the same one unless it agrees otherwise.
Partial paydowns above any allowance in the note. Some notes let you prepay part of the balance each year, often up to 20%, without a fee.
A payoff after default, which many notes treat as a prepayment.

Moving the property into an LLC is not a payoff, but it can breach the loan's due-on-sale clause unless the lender agrees, which could force one.

How to read the clause before you sign

The penalty lives in the note or a prepayment rider attached to it. Ask, and get in writing:

How long, and what shape? 5-4-3-2-1, 3-2-1, flat, months of interest, or yield maintenance.
A percentage of what? The amount prepaid, the current balance or the original loan amount.
When does each year start? Usually the note date, sometimes the first payment date.
Are partial paydowns free up to a limit each year?
Does it apply to a sale, a refinance, or both?
What does each shorter option cost in rate?
Is any of it waived, for example on a refinance with the same lender?

Can you avoid a prepayment penalty?

Before closing, yes: choose a shorter penalty or none and pay for it in rate, and at some lenders buy the penalty down with points instead. After closing, the terms are fixed, so the levers are timing (pay off just after a year rolls over), using any free partial paydown allowance, and asking your lender whether it waives the fee for a refinance it keeps. GoDoor's quote calculator shows how the payment changes with the rate, which is the other half of the trade.

Frequently asked questions

Do all DSCR loans have a prepayment penalty?

Most do, because the private investors who buy DSCR loans price them on years of expected interest. But it is a choice on almost every program: lenders commonly offer five, three, two and one year options, and often none at all, each at a different rate. Ask for every option on the same term sheet so you can compare them directly.

Can I get a DSCR loan with no prepayment penalty?

Yes, at many lenders, for a higher rate, commonly a half point to a point or more above the same loan with a five-year penalty. It makes sense if you expect to sell or refinance within about two or three years. In states that restrict penalties, a no-penalty loan may be the only option, priced accordingly.

Does the prepayment penalty apply if I sell the property?

Usually yes. Most DSCR penalties are hard penalties: any payoff inside the window, whether from a sale or a refinance, triggers the fee. A soft penalty, charged only on a refinance, exists but is rare on DSCR loans. Check the note, since the wording decides it, and plan any sale or 1031 exchange around the dates.

Is a prepayment penalty tax deductible?

The IRS treats a prepayment penalty on a home mortgage as deductible mortgage interest, as long as it is not a charge for a specific service, and interest on a rental's loan is generally a rental expense. How it applies to your return depends on your facts. This is general education, not tax advice; confirm it with a CPA.

What is a typical prepayment penalty on an investment property?

On a DSCR loan, the most common is a five-year step-down, 5-4-3-2-1, charged as a percentage of the balance you pay off. Three-year step-downs (3-2-1), flat percentages such as 3% or 5% for a few years, and six months' interest on part of the balance are also common. Yield maintenance is mostly on commercial and portfolio loans.

When does the prepayment penalty period start?

Usually on the note date, the day you sign at closing, and each penalty year runs twelve months from there. Some notes count from the first payment date instead. The difference can decide which percentage applies to a payoff near an anniversary, so check the note and time a planned sale or refinance accordingly.

Sources

General education, not financial, tax or legal advice. Figures are examples: rates, rules and programs change, and every lender sets its own. Last checked November 4, 2026.