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Pre-payment penalties are a pretty big deal in commercial real estate financing.
But you'd be surprised how many brokers and investors don't understand the specifics.
I wrote an article on this subject that I'll try to summarize here...
But you'd be surprised how many brokers and investors don't understand the specifics.
I wrote an article on this subject that I'll try to summarize here...
With most agency financing there is something called the prepayment penalty.
It's what you have to pay to the lender if you pay off your loan early.
It's what you have to pay to the lender if you pay off your loan early.
After all, the lender was expecting to get interest on the loan through the loan term and you just cut that short.
They're not down with that.
They're not down with that.
There are different types of prepayment penalties, different ways of assessing what you owe your lender.
The two most common are called "yield maintenance" and "step down".
The two most common are called "yield maintenance" and "step down".
Yield maintenance is like a floating penalty.
Depending on the economic factors at the time of payoff, your penalty will be calculated to make the lender whole.
Depending on the economic factors at the time of payoff, your penalty will be calculated to make the lender whole.
Have interest rates dropped and you still have several years left on your term? Then expect to pay up big.
Have rates increased? You may be in luck as the lender can get a better return elsewhere so you won't be penalized for letting them out of their obligation early.
Have rates increased? You may be in luck as the lender can get a better return elsewhere so you won't be penalized for letting them out of their obligation early.
Step-down is a pre-determined schedule based on the hold period.
So you know on day one of your loan what the penalty would be if you sold in year three.
So you know on day one of your loan what the penalty would be if you sold in year three.
Step down schedules come in lots of different forms, but it's usually defined as a % of remaining loan balance.
On a five year term loan the "standard" is 5-4-3-2-1, meaning 5% of balance penalty if paid off in year one, 4% in year two, etc...
On a five year term loan the "standard" is 5-4-3-2-1, meaning 5% of balance penalty if paid off in year one, 4% in year two, etc...
You can get fancy and pay (in the form of a higher interest rate or up front points) to have an accelerated schedule, like 3-2-1-0-0.
It's really important you choose the right prepayment for your business model.
I can't tell you how many deals I see where the seller is hamstrung because they have an onerous prepayment penalty.
You don't want to be that person.
I can't tell you how many deals I see where the seller is hamstrung because they have an onerous prepayment penalty.
You don't want to be that person.
If you want to learn more, I go into much more detail about how to choose your prepayment structure, and many other factors, in this article. https://flywheeleq.com/news/yield-maintenance-vs-step-down-prepayment
Always appreciate the follow if you're into this kind of thing, and happy to answer any questions.
