The cost of paying off a loan before maturity.
A prepayment penalty is a fee charged by a lender when a borrower pays off a loan before its maturity date. Prepayment penalties exist because the lender priced the loan assuming a specific term — early payoff cuts off the lender's expected interest income, and the penalty compensates for that loss.
Prepay structures vary dramatically across loan products. Step-down is the standard on bridge loans and most DSCR programs — a declining schedule like 5/4/3/2/1 means the penalty is 5% of remaining balance in year 1, dropping by 1% each year, with no penalty after year 5. This is borrower-friendly because the math is simple and short holds aren't crushed.
Yield Maintenance is standard on CMBS, agency, and life-company perm loans. The borrower pays the lender the present value of the lost interest income — calculated as the spread between the loan rate and a comparable Treasury rate, applied to the remaining principal over the remaining term. In high-rate environments YM can be small or zero; in declining-rate environments it can be enormous (sometimes 15–25% of loan balance).
Defeasance is the most complex — the borrower buys a portfolio of Treasury securities that produces exactly the same cash flow as the remaining loan payments, and substitutes the Treasuries for the property as the loan's collateral. The loan continues to perform from the new collateral, and the borrower walks away free of the property. Defeasance is universal on CMBS but typically requires specialized firms to execute and costs $25k–$100k+ in transaction fees alone.
For investors, matching prepay structure to exit plan is critical. A 5-year hold on a 10-year fixed loan with yield maintenance can cost 5–15% of loan balance to exit early in a rate-decline scenario. The same hold with step-down has zero penalty after year 5. The cost of an unplanned exit is invisible at origination but ruinous at execution — read the prepay schedule carefully on every loan.
| Loan balance at year 4 | $2,750,000 |
| 5/4/3/2/1 step-down (current year: year 4) | |
| Penalty: 2% of balance | $55,000 |
| Yield maintenance (rates declined 100 bps) | |
| Spread × remaining balance × remaining years × YM factor | $165,000 |
| Defeasance (rates declined 100 bps) | |
| Treasury portfolio cost vs loan balance + ~$50k execution | $140,000–$180,000 |
| Lockout (year 4 still in lockout) | Cannot prepay — full term required |
A fee charged when a borrower pays off a loan before maturity, compensating the lender for lost interest income. Structures include step-down, yield maintenance, defeasance, and lockout periods.
Step-down structures cost 1–5% of balance depending on timing. Yield maintenance and defeasance can range from 0% to 25%+ depending on rate environment and remaining term.
A declining penalty that drops over time — e.g., 5/4/3/2/1 means 5% penalty in year 1, 4% in year 2, 3% in year 3, 2% in year 4, 1% in year 5, and zero after year 5. Borrower-friendly and predictable.
CMBS loans use defeasance — the borrower has to buy a Treasury portfolio that exactly replicates the remaining loan payments. In low-rate-at-origination, high-rate-now environments, defeasance can actually be cheap. In rate-decline environments, it's very expensive.
On bridge, DSCR, and smaller balance loans, often yes — borrowers can typically choose between step-down structures and pay a slight rate premium for shorter or no prepay. On CMBS and agency, prepay structures are mostly standardized to product.
Matrix structures bridge, DSCR, and rental loans with prepay schedules that match your strategy — step-down, no penalty, or longer-term prepay protection as needed.
