Prepayment penalties are fees charged when a borrower pays off a mortgage before a set period ends. Dodd-Frank's Qualified Mortgage rule prohibits prepayment penalties on most consumer QM loans. But non-QM loans, DSCR loans, and commercial mortgages frequently include them. Knowing how they are structured is essential before placing any borrower into a non-agency product.
Prepayment Penalty Structures
The most common structure in non-QM and DSCR lending is the step-down penalty: 5/4/3/2/1, meaning the penalty is 5% of the balance if paid in year 1, 4% in year 2, and so on until it expires after year 5. Some DSCR lenders use a 3/2/1 or flat 2-year penalty. Hard prepayment penalties apply regardless of why the loan pays off. Soft prepayment penalties exempt payoffs caused by a home sale but apply to refinances.
Disclosure Requirements
On non-QM consumer loans, lenders must disclose the prepayment penalty in the Loan Estimate and Closing Disclosure. Confirm the prepayment penalty box is checked on the Loan Estimate and that the borrower acknowledges the penalty amount. Failure to disclose properly creates RESPA and TILA liability. For investment property DSCR loans, commercial disclosure standards apply, but documenting that the borrower understood the penalty is still best practice.
How Penalties Affect Refinance Planning
- ✦A 5% penalty on a $400,000 DSCR loan is $20,000 -- that wipes out months of cash flow savings from a refi
- ✦Check whether the lender permits penalty waivers for sale of the property
- ✦Some non-QM lenders will waive or reduce the penalty if the borrower refinances with the same lender
- ✦Model the penalty into break-even when presenting a refinance option to a borrower in a penalty period
Aria can outline prepayment penalty structures for specific non-QM and DSCR programs and help model the refinance break-even including the penalty cost. Ask at vicariointel.com.
7-day free trial. No credit card required.
Ask Aria About Prepayment Penalty Structures →