Pre-pay structers can seem complex to a first time investor. However, they are simpler than they seem. Pre-Covid, the “5-Year step down” was the most famous prepayment penalty structure. And while many DSCR lenders still offer that, many offer shorter (and even longer) prepays, based on the rate you desire.
A step down means the penalty reduces each year you own the property. The percentage of the penalty usually starts at the year number. For example, a 5-year step down, if you refinance or sell in year one, the penalty is 5% of the remaining loan balance. In year two, it goes to 4%, year three is drops to 3%, etc. Lenders usually offer a 3-year step down (3-2-1), a 1-year, and even a no prepay option. Keep in mind, the shorter the prepay, the higher the rate.
Sometimes it still works out. If you’re optimistic rates will come down in the near future or you plan to sell soon, reducing the prepay is your best bet. Yeah, doing a 1-year prepay option may increase the rate by 45 bps, but paying an extra .45% for a year is much better than selling or refinancing in a year and being hit with a 4% penalty.