Do Non-QM Loans Have Prepayment Penalties? What You Need to Know
This is one of the most important questions to ask when considering a Non-QM loan — and one that often gets glossed over. Yes, Non-QM loans can carry prepayment penalties. Understanding how they work and when they apply will help you make an informed decision.
What Is a Prepayment Penalty?
A prepayment penalty is a fee charged if you pay off your loan — either by selling, refinancing, or making large unscheduled principal payments — before a specified period ends. On Non-QM loans, these penalties are structured to protect lenders who price loans for a minimum hold period.
How Non-QM Prepayment Penalties Are Structured
Non-QM prepayment penalties are offered in terms of 1, 2, 3, 4, or 5 years and typically use one of two penalty structures:
| Structure | How It Works |
|---|---|
| Percentage-based (Step-Down) | A percentage of the prepaid amount, declining each year. Example: 5%–4%–3%–2%–1% over a 5-year term |
| 6 Months Interest | A fee equal to 6 months of interest on the amount prepaid beyond the annual 20% allowance |
When Prepayment Penalties Apply
The penalty applies any time unscheduled principal is received within the penalty term — including when the loan is paid off in full (sale or refinance). On the 6-month interest structure, you can prepay up to 20% of the original loan balance per year without triggering a penalty; amounts above that threshold are subject to the fee.
When Prepayment Penalties Are NOT Allowed
Prepayment penalties are generally not permitted on:
- Primary residences (varies by state and program — confirm with your loan officer)
- Second homes
- Investment property cash-out transactions where proceeds are used for personal purposes
DSCR programs and other investment-purpose loans are where prepayment penalties most commonly appear, since these are treated as business-purpose loans outside of standard consumer protections.
Why Non-QM Loans Carry Prepayment Penalties
Non-QM loans are priced with a premium to account for the additional risk and flexibility of the program. Prepayment penalties allow lenders to offer more competitive rates to borrowers who commit to holding the loan for a defined period. Borrowers who want no prepayment penalty can usually choose a zero-penalty option — typically at a slightly higher rate.
What the penalty could cost: two illustrative examples (not quotes)
Step-down structure. Take a $400,000 balance and a 5-4-3-2-1 schedule. Paying off in the second year costs 4%, which is $16,000. Waiting until the fourth year drops the charge to 2%, or $8,000. The cost falls the longer you hold.
Six months of interest structure. Assume a $400,000 original balance and a 7% rate, used only for the arithmetic. You may prepay 20% of the original balance each year, which is $80,000. If you sold and paid off the full $400,000 in that year, the excess is $320,000, and six months of interest on it is $320,000 × 0.07 ÷ 2 = $11,200. A partial $120,000 prepayment would exceed the allowance by $40,000, so the fee would be $40,000 × 0.07 ÷ 2 = $1,400.
How to decide on a term
- Estimate how long you will realistically keep the loan: sale, refinance, or a payoff from another source.
- Ask for the same loan quoted with a zero-penalty option and with each available term.
- Compare the monthly savings from a shorter or no penalty against the possible fee at your expected exit date.
- Choose the term that covers your holding plan with a margin, not just your best-case timeline.
Mistakes to avoid
- Picking the longest term for the best pricing, then selling in year two.
- Assuming the structure is the same on every loan; it is set in the note for each loan.
- Forgetting that a refinance counts as a payoff and triggers the same fee.
Frequently asked questions
When does the penalty period start?
The term is defined in your loan documents, so confirm the start date and length in the Note and on your Loan Estimate. We confirm the current guidelines when we review your scenario.
What happens when the penalty term ends?
The fee drops away and you can pay off or refinance without it. Mark the date on your calendar if you plan an exit.
Is it worth paying for a zero-penalty option?
If your timeline is uncertain, often yes. A slightly higher rate is a known monthly cost, while a penalty is a one-time cost that depends on events you may not control.
Related guides
- Buying with a DSCR loan
- Refinancing a Non-QM loan
- Weighing the trade-offs
- Mortgage payment calculator
Key Takeaways
- Non-QM loans can carry prepayment penalties of 1–5 years
- Two structures: percentage step-down (e.g., 5%–4%–3%) or 6 months of interest on excess prepayments
- Penalties most commonly apply to investment/DSCR loans, not primary residence consumer loans
- Zero-penalty options are available — typically at a slightly higher rate
- Always review your Loan Estimate and Note for the exact penalty structure before closing
- On a $400,000 balance, a 5-4-3-2-1 step-down costs $16,000 in year two but $8,000 in year four (illustrative example)
- A refinance counts as a payoff, so it triggers the same penalty as a sale
- Ask for quotes with a zero-penalty option and each term, then compare against your realistic exit date
Serving borrowers throughout California — Orange County, Los Angeles County, Riverside County, San Bernardino County, San Diego County, and the greater Southern California region including Santa Ana, Irvine, Anaheim, Huntington Beach, Fullerton, Garden Grove, and surrounding communities.