On a home you live in: almost never, and never on non-QM
For a loan on your own home, federal rules allow a prepayment penalty only when three things are all true: the rate cannot increase after closing, the loan is a qualified mortgage, and it is not a higher-priced loan.1
A non-QM loan is, by definition, not a qualified mortgage. So a non-QM loan on a home you live in cannot carry a prepayment penalty, whatever the program and whatever the lender.1
Even where a penalty is allowed, on a qualifying fixed-rate loan, it is limited to three years and to 2 percent of the balance prepaid in the first two years and 1 percent in the third.1
If you are shown an owner-occupied non-QM loan with a prepayment penalty on it, stop and ask about it before anything else.
On an investment property: common, and legal
A DSCR loan or other loan on a rental you do not live in is business-purpose credit, outside the consumer mortgage rules.2 The limits above do not apply, and most investor loans carry a penalty. Some state laws still restrict them, so the terms can vary with where the property is.
What they look like
| Structure | How it works |
|---|---|
| Step-down, e.g. 5-4-3-2-1 | 5 percent of the balance if paid off in year one, 4 in year two, down to 1 in year five, then nothing |
| Shorter step-down, e.g. 3-2-1 | Three years, stepping down each year |
| Flat | The same percentage for the whole penalty period |
| Months of interest | A set number of months’ interest on the amount prepaid |
| None | Available on many programs, at a higher rate |
Illustrative structures, not a quote. The terms on any loan are in its note and its prepayment rider.
It is a trade, not a trap
The penalty buys you something: a lower rate. The lender is paid to expect your loan to stay on its books, and it prices it accordingly. A longer, heavier penalty usually means a lower rate; no penalty usually means a higher one.
So the right structure depends on your plan. Holding the property for ten years? A five-year penalty may cost you nothing and save you real money every month. Planning to renovate and sell, or to refinance when rates drop? A penalty can wipe out the savings. We price the options side by side and show you the year each one breaks even.
What to ask before you sign
- Is there a prepayment penalty, and for how many years?
- What percentage in each year, and on what balance — the full payoff, or only the amount above a yearly allowance?
- Does a sale trigger it, or only a refinance?
- What would the rate be with a shorter penalty, or none?
Sources
These references support the factual explanations above. Where this page states a preference rather than a fact, it says so — those are our editorial judgement, not a claim that any one channel always costs less.
Next
DSCR loans: qualifying on the rentYour tax returns stay in the drawer. The question is whether the property pays for itself.Non-QM: what it is, and what it is notNot a subprime loan and not a no-documentation loan. A different way of proving the same thing.Bring us the file that doesn’t fit
Tax returns that undersell you, a rental portfolio, an ITIN, a thin credit file. Tell us what you have. We will look at whether a conventional loan works before we look at a non-QM one, and tell you plainly which is cheaper.