Prepayment penalties are often the most expensive and overlooked element of DSCR loans. They impact investors at every level — whether you’re a seasoned investor managing multiple properties or closing your very first deal.

Understanding these penalties can significantly influence your investment's success. Get it wrong, and you could pay thousands in unnecessary fees. Get it right, and you could lower your rate and align financing with your investment goals.

Here’s the full guide, including state-specific rules, common penalty structures, and real-world examples.

Why DSCR Loan Prepayment Penalties Matter

Lenders charge prepayment penalties to guarantee a return if you pay off a loan early. For investors, this limits flexibility in refinancing or selling. The key is understanding the balance between upfront costs, interest rates, and exit strategy.

👉 Big takeaway: Prepayment penalties aren’t just “fine print” — they’re a pricing lever that can make or break your deal.

State-Specific Prepayment Penalty Rules

The first step is knowing your state’s laws. Some states protect borrowers by banning penalties entirely, while others allow them with limits. A handful let lenders do whatever they want.

States That Ban Prepayment Penalties Entirely

• Iowa

• Kansas

• Minnesota

• New Mexico

States With Limits or Restrictions

• Arkansas – Allowed up to 3 years; step-down up to 3-2-1%.

• District of Columbia – Max 3 years; penalty capped at 2 months’ interest.

• Georgia – Allowed only up to 2 years; 2% penalty in year 1, 1% in year 2.

• Hawaii – Max penalty is 6 months’ interest.

• Illinois – Prohibited for individual borrowers; not allowed if APR > 8%. In Cook County, banned for loans ≤ $250K. Step-downs up to 5-4-3-2-1%.

• Kentucky – Allowed up to 3 years; step-down up to 3-2-1%.

• Louisiana – Step-down allowed up to 5-4-3-2-1%.

• Massachusetts – Max 3 years; capped at 3 months’ interest.

• Maryland – Max penalty is 2 months’ interest.

• Maine – Not allowed on ARM loans.

• Michigan – Max 3 years; penalty capped at 1%.

• Mississippi – Step-down allowed up to 5-4-3-2-1%.

• North Carolina – Not allowed on loans ≤ $150K.

• New Jersey – Prohibited for individuals; allowed only in LLC/corporation closings.

• Ohio – Not allowed for loans < $110,223; max penalty 1%.

• Oklahoma – Not allowed if APR > 13%.

• Pennsylvania – Allowed only on 3–4 unit properties, or 1–2 units > $312,159.

• Rhode Island – Allowed only up to 1 year; max penalty 2%.

• South Carolina – Not allowed for loans ≤ $690,000.

• Texas – Not allowed if APR > 12%.

• Wisconsin – Not allowed on ARM loans; max penalty 2 months’ interest.

• West Virginia – Not allowed beyond 3 years; max penalty 1%.

All Other States

Prepayment penalties are generally allowed with no restrictions. Your exact terms depend on the lender’s program.

Common Prepayment Penalty Structures

Once you understand your state’s rules, the next step is knowing the three most common penalty types:

1. Six Months of Interest – Straightforward but potentially costly if you refinance early.

2. Flat 5% Penalty – Simple, but expensive no matter when you exit.

3. Step-Down (Declining) Penalty – Most common: starts high and decreases each year (e.g., 5% → 4% → 3% → 2% → 1%).

👉 Align your penalty type with your investment horizon. Long-term hold? Step-down may work fine. Planning to refinance quickly? Look for the shortest penalty allowed.

How Prepayment Penalties Affect Your Rate

Here’s where most investors miss the boat: your prepayment penalty choice directly impacts your interest rate and upfront costs.

• No penalty → Higher fees (about +1.75 points).

• 1-year penalty → Adds ~1.125 points.

• 2-year penalty → Adds ~0.5 points.

• 3-year penalty → No adjustment (par pricing).

• 4–5 year penalty → Lender credit back to you (0.5–0.875 points).

👉 Translation: flexibility costs money upfront. Commitment lowers your rate or fees.

Real-World Example

$400,000 loan | 80% LTV | 740 FICO | 1.25 DSCR

• 5-Year Penalty → 6.875% rate, no points.

• 1-Year Penalty (same rate) → 2 discount points ($8,000).

• 1-Year Penalty (no points) → Higher rate, 7.25%.

Protect Yourself: Questions to Ask

• What is the prepayment penalty tied to this rate?

• Can I make extra principal payments without penalty?

• Is it waived in the last 90 days of the term?

• Can I see it in writing in the disclosures?

• Does the lender charge extra for waiving escrows or closing in an LLC?

Choosing the Right Lender

The lender you choose can make or break your DSCR financing:

• Local banks: Stricter guidelines, limited flexibility.

• Big online lenders: Convenience, but little DSCR expertise.

• Specialized brokers: Access to dozens of DSCR lenders, tailored fit, and ability to structure around penalties.

Pick someone who understands investor loans and can act as your partner, not just a transaction.

Common Mistakes to Avoid

• Not shopping around (different lenders = very different penalty structures).

• Relying too heavily on word-of-mouth without due diligence.

• Ignoring the fine print.

• Choosing a short penalty for “flexibility” but overpaying thousands upfront.

Final Thoughts

Prepayment penalties are not just fine print — they’re one of the most important levers in structuring your DSCR loan.

By:

• Understanding your state’s rules,

• Choosing the right penalty structure,

• Asking the right questions, and

• Partnering with an experienced DSCR lender...

…you’ll save money and avoid costly surprises.

👉 Ready to see how this plays out on your own deal?

Text me at 619-404-6637, email me at [email protected], or schedule a one-on-one with me today.