What is Prepayment?
Prepayment occurs when a borrower pays off a mortgage balance before maturity (the end of the loan term). The FHA requires prior approval for the prepayment of HUD multifamily loans. In most cases, HUD multifamily loans require a prepayment penalty, which reimburses the lender if the borrower attempts to pay off the loan early. Most HUD multifamily loans have a two-year lockout (a period in which the borrower cannot repay the loan at all), followed by an 8-1% declining prepayment penalty.
Prepayment Definition
Prepayment occurs when a borrower pays off a mortgage balance before maturity (the end of the loan term). The FHA requires prior approval for the prepayment of HUD multifamily loans. In most cases, HUD multifamily loans require a prepayment penalty, which reimburses the lender if the borrower attempts to pay off the loan early. Most HUD multifamily loans have a two-year lockout (a period in which the borrower cannot repay the loan at all), followed by an 8-1% declining prepayment penalty.
For example, if a borrower wanted to prepay the loan in the third year, they would face an 8% penalty, in the fourth year, a 7% penalty, and after the tenth year, they could prepay the loan with no penalty at all. If a HUD multifamily borrower wants to refinance their loan with the HUD 223(a)(7) program before the end of the penalty period, they can roll that penalty into the cost of their new 223(a)(7) loan.
To learn more about the HUD 223a7 refinance program, fill out the form below to speak to a HUD/FHA loan expert.
Related Questions
What is the definition of prepayment?
Prepayment occurs when a borrower pays off a mortgage balance before maturity (the end of the loan term). Most HUD multifamily loans have a two-year lockout (a period in which the borrower cannot repay the loan at all), followed by an 8-1% declining prepayment penalty. For example, if a borrower wanted to prepay the loan in the third year, they would face an 8% penalty, in the fourth year, a 7% penalty, and after the tenth year, they could prepay the loan with no penalty at all. If a HUD multifamily borrower wants to refinance their loan with the HUD 223(a)(7) program before the end of the penalty period, they can roll that penalty into the cost of their new 223(a)(7) loan.
What are the advantages of prepayment?
The main advantage of prepayment is that it allows borrowers to pay off their loan earlier than expected, without incurring any additional costs beyond the loan's balance. This adds to the flexibility of bridge loans, as they generally do not have prepayment penalties attached. Step-down prepayment is arguably the most reasonable prepayment risk mitigation strategy, as it doesn’t particularly punish a borrower for paying their debt early. With step-down prepayment, the borrower agrees to pay a lower interest rate on the balance in order to prepay the loan. The premium amount depends on how far into the loan term the borrower is, and typically reduces as the maturity date gets closer. More information on prepayment penalties and step-down prepayment can be found online.
What are the disadvantages of prepayment?
The main disadvantage of prepayment is that it can be expensive for the borrower. This is because lenders often include call protection in their loan products, which are expensive prepayment penalties. Additionally, prepayment can limit the borrower's ability to recapitalize their loan, either through a sale or refinance.
Prepayment risk is a risk to lenders because it means they are denied their expected interest payments when the loan is paid in full before reaching its maturity date. This can be a significant amount of money, especially if the loan was for a large amount and had a long term.
What are the different types of prepayment?
The three main types of prepayment penalties for commercial real estate loans are defeasance, yield maintenance, and step-down prepayment. Defeasance involves replacing the loan with a portfolio of government securities. Yield maintenance requires the borrower to pay a penalty equal to the difference between the original interest rate and the current market rate. Step-down prepayment involves a penalty that decreases over time. In relation to HUD 232 financing, prepayment usually has a two-year lock out period followed by a 8%- 1% step down premium (i.e. 8,7,6,5,4,3,2,1).
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How does prepayment affect a loan?
Prepayment affects a loan by potentially resulting in a fee that borrowers have to pay if they want to prepay their loans. This fee can depend on the terms of the loan, and can sometimes be a significant amount of money. Beyond charging a simple or flat fee as a penalty, there are also more complex forms of prepayment penalties that are aimed at giving the lender a more fair return should the debt be paid off before fully maturing.
In most commercial real estate deals, lenders opt to implement one of three common strategies – defeasance, yield maintenance, and graduated or “step-down” prepayment.
Commercial borrowers should always try to determine the potential costs or rewards for prepaying their commercial loan. If you would like to find out how you can get commercial financing with prepayment penalties that won’t hinder your future investment goals, you can fill in the form here to get a free quote.
What are the risks associated with prepayment?
Prepayment of a commercial loan can be costly for the lender, as they are denied their expected interest payments when the loan is paid in full before reaching its maturity date. This can be a significant amount of money, especially if the loan was for a large amount and had a long term. Lenders protect themselves from prepayment risks by originating a loan with a prepayment penalty or a lockout clause. Commercial borrowers should always try to determine the potential costs or rewards for prepaying their commercial loan.
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