Prepayment penalties are a core feature of most DSCR loans, and understanding them is essential before you finance a real estate investment property. 

Prepayment penalties (PPP) play a major role in how DSCR loans are priced as well as how much flexibility you have to sell or refinance your property within the first three to five years of ownership. The PPP you choose directly affects your interest rate, monthly cash flow, and overall investment strategy.

This guide explains how DSCR prepayment penalties work, how each structure impacts your ability to exit the loan, how state laws influence PPP availability, and how to select the right option within a modern DSCR loan program. 

By the end of this article, you’ll understand which PPP term best supports your target holding period, projected rental income, and long-term real estate goals.

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What Is a Prepayment Penalty on a DSCR Loan?

A prepayment penalty is a contractual fee you pay if you sell, refinance, or otherwise pay off your DSCR loan earlier than allowed under the prepayment schedule. In exchange for accepting that limitation, the lender offers a better interest rate. Prepayment penalties guarantee lenders future receivables throughout the specified prepayment period and as such, lenders can lower the “maturity premium” in the DSCR loan credit spread calculation when determining the loan interest rate.

For DSCR loans, prepayment penalties are expressed as a percentage of the loan:

• For example, a declining pre-payment penalty schedule: such as 5–4–3–2–1, means the prepayment penalty “steps down” every year for the first five years. So, if you pay off the loan in year one, you pay 5% of the remaining principal balance, if you pay off the loan in year two, you pay 4% of the remaining principal balance, and so forth. 

The penalty only applies if you pay off additional principal (ahead of the contractual mortgage repayment schedule) through a sale, refinance, or cash buydown during the penalty period.

Lenders typically offer a number of prepayment options, including 1-year, 3-year, and 5-year terms, and a no-penalty option.

The core tradeoff is simple: A longer PPP term means a lower interest rate because the lender has predictable cash flow. A shorter or no-PPP term means a higher rate because you maintain exit flexibility, increasing the lender's prepayment risk.

Investors holding real estate assets long-term often choose a longer PPP to capture better pricing. Investors planning an early sale, value-add repositioning, or quick refinance typically opt for shorter or no-PPP structures to avoid penalties and keep maximum control over their exit.

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Why DSCR Loans Have Prepayment Penalties

DSCR loans are designed for holding rentals long term and lenders price them with the expectation that the loan will remain on their books for several years. A prepayment penalty protects that expected interest income and allows the lender to offer more competitive rates.

Prepayment penalties help lenders manage two core risks:

• Early refinances when market rates drop
• Quick resales that shorten the loan’s life

By committing to a set prepayment penalty period, the lender’s future receivables (in the form of mortgage interest payments) are protected. As such, the lender can offer lower interest rates with less uncertainty about the loan being paid off early.

Investors planning value-add improvements, early refinances, or potential resales often choose a shorter or no-PPP structure, accepting a higher rate in exchange for exit flexibility.

When a Prepayment Penalty Does Not Apply

Prepayment penalties don’t apply in every situation. If you pay off the loan after the contractual pre-payment penalty period or if you selected a “no prepayment penalty” option, then you will not be required to pay any pre-payment penalty. 

One common question that is also asked by real estate investors is: What if I make an extra-payment every year or I want to pay off only part of my mortgage?

The answer is: Pre-payment penalty only applies to the principal balance being paid off early. So if you pay $2,000 early, you only pay the penalty on that amount - not the full loan balance.

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Prepayment Penalty Options on DSCR Loans

5-Year PPP

The 5-year structure delivers the lowest rates because it gives lenders the longest yield protection. It’s the preferred option for long-term rental holders focused on maximizing cash flow. Penalties are offered as either a declining schedule such as 5% in year one dropping to 1% in year five, or a fixed percentage applied for the first 5 years.

3-Year PPP

The 3-year option fits investors planning multi-year holds who still want exit flexibility before year five. Rates sit above 5-year pricing but below shorter terms. Penalties typically decline across the three years (for example, 3%–2%–1%) and balance lender security with borrower mobility.

1-Year PPP

Designed for value-add strategies or refinances within 12–18 months, the 1-year PPP carries higher rates because lenders face earlier payoff risk. The penalty is usually a single-year percentage, commonly 2–3% if the loan is paid off during the first year.

0-Year / No PPP

For investors who need full flexibility for early sales, or timing-sensitive refinances, the no-PPP option removes all penalty restrictions. Pricing is the highest to reflect full prepayment exposure to the lender. This structure is also standard in states where PPPs are restricted or prohibited.

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Do PPPs Affect DSCR Qualification?

Your PPP choice does not change how lenders calculate DSCR. Underwriting is still based on the property’s rental income, expenses, and the resulting debt service coverage ratio, usually requiring DSCR ≥ 1.0.

However, shorter or no-PPP structures can increase your interest rate, which raises your monthly payment and may reduce your DSCR. For investors near minimum DSCR thresholds or pushing maximum LTV, this small difference can affect loan feasibility or loan amount.

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States Where DSCR Prepayment Penalties Are Limited or Prohibited

Prepayment penalty rules vary widely by state, and several jurisdictions restrict or completely ban PPPs on investment property loans. Because DSCR loans are non-QM products originated to LLCs or other entities, they fall under a mix of state lending laws and lender-specific program matrices. 

Understanding these rules is important, since your state may determine whether a PPP is allowed at all.

States That Prohibit PPPs

A handful of states do not allow prepayment penalties on DSCR or similar non-QM investment loans under any circumstance. These include the following:

• Kansas (KS)
• Minnesota (MN)
• New Mexico (NM)

Many lenders also treat North Dakota (ND) as a prohibited state due to program guidelines and usury considerations.

Borrowers in these states receive automatic no-PPP structures, and pricing adjusts to reflect the lack of penalty protection for the lender.

States with Significant Restrictions

Several states allow PPPs only under limited conditions, usually tied to borrower type, loan size, or APR thresholds. Here are some common examples:

• New Jersey (NJ): PPPs prohibited for individuals, permitted for LLCs.
• Ohio (OH): Prohibited on loans under certain dollar amounts (approximately ~$110,000).
• Illinois (IL): Not allowed for individuals, limited for entities when APR falls below defined thresholds.
• Pennsylvania (PA): Restricted for loans below specific loan amounts on 1–4 unit rental properties.
• Rhode Island (RI): Rules vary by maximum PPP duration, loan size caps, or percentage limits.

In these states, PPP availability depends on how the loan is structured and who is borrowing (individual vs. LLC). Lenders typically default to no-PPP pricing unless state law clearly permits a penalty term.

How Lender Type Affects PPP Legality

Not all lenders operate under the same constraints:

• Banks and depository institutions face stricter state-level consumer lending rules and often cannot offer PPPs on 1–4 unit properties, even to real estate investors.
• Private and non-bank DSCR lenders (portfolio lenders) have more flexibility. Many structure PPPs through entity vesting, allowing penalty terms in states where banks cannot offer them.
• Agency-style lenders rarely offer PPPs at all due to uniform post–Dodd Frank guidelines.

Each lender publishes a state eligibility matrix outlining whether 5-, 3-, 1-, or 0-year PPPs are permitted. These matrices frequently differ between lenders, even within the same state.

What Investors Should Expect

If you’re investing in a state with PPP bans or tight restrictions, expect the following:

• You will receive a no-PPP DSCR loan by default.
• Your interest rate will be higher than in PPP-permitted states.
• Comparing pricing between 0-year and 1-year options (if allowed) is important.
• Entity structure (LLC vs. individual) can materially change eligibility.

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How to Choose the Right PPP for Your DSCR Loan

Selecting the right prepayment structure starts with your expected holding period for your real estate investment. Longer PPPs improve pricing; shorter or no-PPP terms keep your exit fully flexible. Choose the option that supports the timeline you are most likely to execute.

For long-term holds, a 5-year PPP delivers the strongest cash flow because it offers the lowest rate. Penalty risk fades quickly as the property stabilizes and the hold period extends.

For 2–4 year plans, a 3-year PPP keeps pricing competitive while allowing a clean exit once the penalty period ends.

If you expect a 12–18 month refinance, a 1-year PPP limits penalty exposure on value-add or stabilization deals while avoiding the cost of a no-PPP structure.

When flexibility is the priority (or the exit timeline is unclear), a no-PPP option removes all penalties and keeps capital mobile, even though pricing is higher.

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Get the Right DSCR Loan Structure with Ridge Street

Prepayment penalties only work in your favor when they match your timeline. Whether you’re building long-term cash-flow rentals or planning a refinance after stabilization, the right PPP structure protects your returns while keeping your strategy on track.

Ridge Street makes that alignment simple. Our DSCR program lends in 35 states, with rates starting at 6.25%, LTVs up to 80%, and closings in 21–25 days. Every loan includes a clear menu of PPP options (5-year, 3-year, 1-year, and no-PPP), so you can compare pricing and flexibility side by side.

With a 660+ minimum credit score, DSCR as low as 1.0, and no experience required, we fund everyone from first-time landlords to seasoned portfolio investors. Our team handles everything from pre-approval to closing with a streamlined, five-step process that keeps deals moving and removes the guesswork.

If you’re ready to secure DSCR Loan terms that support your long-term plan, start with an online pre-approval or request a term sheet. 

Ridge Street is here to help you finance your next rental confidently and efficiently.

Get Approved Online

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DSCR Loan Prepayment Penalty FAQs

Do all DSCR lenders allow partial prepayments without penalty?

Partial payments are subject to the pre-payment penalty if paid off within the prepayment penalty period. Only the partial principal balance being paid off early is subject to the penalty, not the full loan amount.

Does borrowing in an LLC change whether PPPs are allowed?

Yes. In several states, PPP restrictions apply only to individual borrowers, not LLCs. Real estate investors financing rental income generating properties through an entity may gain access to PPP structures that aren’t available to natural persons. Always review the lender’s state matrix to confirm.

Are PPP rules different for short-term rental DSCR loans?

The penalty structures are the same, but pricing spreads are often wider because projected rental income on short-term rentals is more variable. Investors relying on seasonal or volatile property cash flow sometimes choose shorter PPP terms to keep exit timing flexible.

How do PPPs work on DSCR portfolio or blanket loans?

Portfolio DSCR loans apply the penalty only to the specific properties paid off during the PPP window, rather than the entire portfolio. This structure helps investors manage multiple rental properties, preserve liquidity, and avoid penalties on assets they plan to hold long-term.

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