What is Prepayment Penalty?
A prepayment penalty is a contractual fee charged to borrowers who pay off a loan before its scheduled maturity date. The purpose is to protect the lender's expected yield by discouraging early payoff. Common structures include yield maintenance (compensates lender for lost interest based on Treasury rates), defeasance (borrower substitutes government securities for the collateral), and declining percentage penalties (e.g., 5% in year 1, 4% in year 2, declining to 0%). Prepayment penalties are common in commercial loans and some non-QM residential loans. They significantly reduce CPR during the penalty period.
How LoanBook Uses Prepayment Penalty
The LoanBook Prepay Model slows prepayment while a penalty is in force: a hard penalty cuts the speed by 85% and a soft penalty by 30%. SBA 7(a) loans follow the SBA 3-2-1 penalty schedule over the first 3 years. Fixed-rate commercial real estate takes its payoff date from the CRE Payoff Model, which projects no payoff while yield maintenance, defeasance or a lockout is in force.
Frequently Asked Questions
Do residential mortgages have prepayment penalties?
Most conforming residential mortgages (Fannie Mae/Freddie Mac) do not have prepayment penalties; they were largely eliminated after the 2008 financial crisis. Some non-QM and commercial residential loans still include them. SBA 7(a) loans have a declining penalty in the first 3 years.
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