Prepayment Penalties Explained: The Cost of Paying Off Early

A prepayment penalty is a charge you owe if you pay off a loan before a set date. It protects the lender's expected interest income. The terms live in your note, so they are fixed at closing.

Common structures

• Step-down: a percentage of the balance that drops each year, for example 3%, then 2%, then 1%.
• Flat fee: one fixed percentage or dollar amount during a set window.
• Yield maintenance: a formula that makes the lender whole for lost interest. Common on larger commercial loans.
• Lockout: a stretch where early payoff is not allowed at all.

You see these most on long-term rental debt, such as DSCR (debt service coverage ratio) loans. Short-term flip and bridge loans are less likely to carry one, but always check.

A simple example

Example, round numbers. You hold a rental with a $400,000 DSCR loan on a 3-2-1 step-down. In year two you get an offer to sell. The penalty is 2% of $400,000, or $8,000. If the sale nets you $40,000 more than holding another year, paying it may still make sense. If not, waiting could be the better move.

Why it matters to you

A sale and a refinance both count as payoff. Match the penalty schedule to your realistic hold period, and put the fee into your exit math before you sign. Also check whether the percentage applies to the original loan amount or the balance at payoff, and whether a partial paydown triggers it.

At RSC Private Lending, Bridge loans carry no prepayment penalty. DSCR Rental loans are 30-year fixed with prepayment options from a 5-year step-down to no prepayment penalty, so pick the option that matches how long you expect to hold. Send us your scenario for a term sheet in 24 hours. Subject to underwriting.