Non-QM Loan Prepayment Penalties: Guidelines Every MLO Should Know

Prepayment penalties on Non-QM loans are not uniformly structured. Bank statement loans, asset depletion loans, and portfolio products each carry distinct penalty terms depending on the lender, the LTV, and the loan purpose. MLOs need to understand these terms to counsel borrowers accurately and avoid compliance issues.

Prepayment Penalty Regulation on Non-QM Loans

The Dodd-Frank Act and Regulation Z restrict prepayment penalties on Qualified Mortgages (QM); they are prohibited on higher-priced loans and capped at 2% on most QM products. Non-QM loans fall outside the QM safe harbor, which gives lenders more flexibility in structuring penalties.

That flexibility does not eliminate disclosure requirements. TILA and RESPA require that prepayment penalty terms be clearly disclosed on the Loan Estimate (LE) and the Closing Disclosure (CD). Borrowers must also receive specific state disclosures where required.

Common Penalty Structures by Product Type

• ✦Bank statement loans: most lenders use step-down structures (5-4-3-2-1 or 3-2-1) with full payoff triggering the penalty; some allow annual 20% curtailment without penalty
• ✦Asset depletion and asset utilization loans: penalty structures vary by lender; longer penalty periods are more common on high-balance or jumbo asset depletion loans
• ✦DSCR and investor loans: step-down penalties are standard; no-penalty options exist at rate premiums
• ✦Foreign national loans: penalties are common and sometimes structured as flat percentages for a fixed period rather than declining step-downs
• ✦Recent credit event (non-prime) loans: penalties may be shorter or waivable depending on credit profile and LTV

Disclosure Requirements for MLOs

The LE must reflect the prepayment penalty accurately on page 1 under Loan Terms. If a prepayment penalty applies, the 'Yes' box must be checked and the maximum penalty amount stated. Failure to disclose a penalty that later appears on the CD creates a tolerance cure obligation and potential RESPA liability.

State-specific rules add another layer. Some states prohibit prepayment penalties on owner-occupied properties beyond specific durations; others require separate borrower acknowledgment forms. Confirm your state's requirements before proceeding on any owner-occupied Non-QM loan.

How to Counsel Borrowers on the Penalty Decision

Borrowers sometimes underestimate the likelihood that they will want to refinance or sell within the penalty window. Walk them through realistic scenarios: what if rates drop 150 basis points in year two? What if they need to sell to relocate for work? The penalty cost should be part of the decision, not a surprise.

• ✦Calculate the maximum penalty amount in dollars for the borrower's specific loan amount
• ✦Explain the step-down schedule in plain language so they know how the penalty changes each year
• ✦Compare the rate difference between a penalty product and a penalty-free option if available
• ✦Confirm whether a refinance within the same lender triggers the penalty or whether portfolio retention programs waive it
• ✦Document the conversation and the borrower's acknowledgment of the penalty terms

Red Flags to Watch For

Some Non-QM lenders include prepayment penalty provisions that apply to partial prepayments as small as one extra monthly payment. Others include yield maintenance clauses that are difficult to calculate in advance. Read the note carefully before advising the borrower on curtailment strategies.