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Understanding Prepayment Penalties for Multifamily Apartment Loans


When choosing a loan to purchase a multifamily apartment complex, it is important to understand the prepayment penalty terms outlined in your contract.

A good understanding of prepayment penalties can help you determine if the loan is the right fit for you and calculate the financial cost of paying the loan off early.

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What is a Prepayment Penalty?

A “prepayment penalty” is the charge incurred when you pay off your loan ahead of the expected date. Paying off a large loan early can save you thousands of dollars in interest – but it costs the lender the same in projected revenue. Lenders institute prepayment penalties to protect themselves against the loss of interest income if the loan is paid off earlier than expected.

If you have a mortgage on your own home, you may already be familiar with the concept of a prepayment penalty; this works in the same way for multifamily apartment owners.


Types of Prepayment Penalty

There are several different types of prepayment penalties to be aware of relating to various multifamily apartment transactions.


HUD Multifamily Program Loan Prepayment Penalties

When it comes to loans for HUD Multifamily Programs, the most common prepayment penalty gradually declines through the first ten years of the term. The penalty to refinance starts at 10% in the first year and is reduced by 1% each year through the first ten years of the term.

Alternatively, there is a 2-year lockout, followed by a prepayment penalty of 8%, 7%, 6%, 5%, 4%, 3%, 2%, 1% for the following 8 years. The lockout period and penalty percentage may be modified; however, this results in an increase in the interest rate.

HUD multifamily programs are assumable, and if the new borrower qualifies, they can assume the loan, and the seller avoids the prepayment penalty.


Fannie Mae & Freddie Mac Multifamily Prepayment Penalties

Many Fannie Mae and Freddie Mac loan programs also known as agency loans have a Yield Maintenance prepayment structure.

What is Yield Maintenance?

Agencies securitize their loans; they sell them as mortgage-backed securities. The resulting prepayment penalty structure allows the lender to receive the same yield as if the borrower kept the loan through the maturity date.

As explained by Investopedia, the formula for yield maintenance is as follows:

Yield Maintenance = Present Value of Remaining Payments on the Mortgage x (Interest Rate - Treasury Yield)

Agency loans can be structured so that the yield maintenance ends a few years before the loan’s maturity date. This gives the borrower more flexibility but will result in an increased interest rate.


Conduit/CMBS Loan Prepayment Penalties

When it comes to commercial real estate and conduit/CMBS loans, defeasance is the most common type of prepayment penalty.

What is Defeasance?

Defeasance enables the borrower to walk away from their loan and replace it with a portfolio of U.S. government securities (for example, Treasury Bills and various bonds) of the same value.

Rather than paying off the loan and having to pay fees, the borrower substitutes collateral. Lenders use this prepayment penalty to ensure that they have a ‘guaranteed’ income stream.

If you need to sell or refinance, defeasance can provide you with options. Once your loan is replaced with securities via defeasance, you can sell the property as you wish, without transferring the mortgage to the new buyer.


Find a Loan That’s Right for You

Whether you’re still looking for the multifamily apartment loan that best suits your circumstances or need to know more about prepayment penalties on a loan you already have, we can help.

LSG Lending Advisors specializes in HUD Loans as well as Fannie Mae and Freddie Mac Loans. We serve those looking for the right solution to fund their multifamily, affordable, senior, and student housing projects.

Contact us or schedule a free phone consultation today. 

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