Glossary › Glossary
A prepayment penalty is a fee or minimum interest obligation charged when a borrower pays off a loan before its maturity date. In hard money lending, prepayment penalties often appear as a minimum interest period — for example, "6 months of interest regardless of when you pay off." For fix and flip investors who flip quickly, this can significantly affect actual loan cost. Always check term sheets for prepayment terms before committing.
Hard money prepayment structures vary:
No prepayment penalty: The borrower pays off the loan at any time and owes interest only for the days the loan was outstanding. If the loan closes and the property sells in 65 days, the borrower pays 65 days of interest. Common with some direct lenders.
Minimum interest period: The borrower owes a minimum number of months of interest regardless of when they pay off. "3-month minimum" means if the property sells in 45 days, the borrower still pays 3 months of interest. "6-month minimum" means 6 months of interest even if the flip is done in 90 days.
Step-down prepayment penalty: More common on DSCR loans than fix and flip. A structured penalty that decreases over time — for example, 5% of the loan balance in year 1, 4% in year 2, 3% in year 3, and so on. After the step-down period ends (often year 5), there is no penalty.
Yield maintenance: Rare in hard money, more common in commercial finance. The lender calculates the difference between the loan's contracted yield and what they could earn reinvesting the proceeds at current rates, and charges the borrower the shortfall.
Lenders originate loans to earn interest income over time. When a loan pays off early, the lender loses the interest they expected. A 12-month loan that pays off in 3 months generates only 25% of its expected revenue.
Prepayment penalties — particularly minimum interest periods — protect the lender from rapid payoffs on loans that cost real money to originate (underwriting time, appraisal costs, legal costs).
Fast flippers. An investor who regularly closes and sells in 60-90 days is acutely affected by a 6-month minimum interest period. On a $300,000 loan at 11%, 6 months of interest = $16,500. If the actual hold was 70 days, the interest should have been about $6,400 — but the minimum adds $10,100. That is real money.
DSCR loans with step-down penalties. A DSCR investor who plans to sell a rental property in year 2 faces a step-down penalty on loans that include them. On a $400,000 loan with a 4% year-2 penalty, that is $16,000 on a planned sale. Many investors do not model this in their projections.
Volatile markets. In uncertain markets, a seller may accept an offer faster than expected. Or the borrower may need to sell quickly for other reasons. No prepayment penalty provides maximum flexibility; minimum interest periods eliminate that flexibility.
Most DSCR rental loans from hard money-adjacent lenders include a step-down prepayment penalty — it is effectively standard on most 30-year DSCR products. This is because the lender is making a long-term commitment (30-year amortization) and needs some protection against immediate payoffs.
When advising DSCR borrowers, be explicit about the prepayment structure. An investor who plans to hold a rental for 3 years and sell should know what year-3 prepayment costs look like before they sign.
Prepayment terms appear under different names:
If none of these appear on the term sheet, ask directly: "Is there a prepayment penalty or minimum interest period on this loan?" Do not assume no penalty means no penalty — confirm it.
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