What You Should Know About Prepayment Penalties
Tuesday, December 16, 2025
In multifamily real estate financing, most transactions involve a combination of debt and equity. In most debt financing, a commercial mortgage loan with a fixed term of five to twenty-five years is used. The lenders in these agreements structure them in a way as to gain a predictable income in terms of interest. However, borrowers sometimes repay their debts before they are due. In such cases, the lenders face a loss of interest income. To cover this loss, lenders charge prepayment penalties.
In this updated 2026 edition, we will examine:
What Prepayment Penalties Are
Why pre-payment penalties can sometimes be beneficial
Current market and regulatory developments in prepayment penalties
As you complete this lesson, you will grasp an important part of prepayment penalties in loan agreements, particularly in light of the increasing multifamily financing market in 2026.
A prepayment penalty is a charge imposed by lenders on borrowers for repaying a loan before the end of its term. Suppose you took a five-year adjustable-rate mortgage for a 50-unit multifamily property, but you refinance or sell your property in two years when you come across a better interest rate; in such a case, you will have to pay a prepayment penalty.
Although it is financially prudent to refinance to lower your monthly payments, this is contingent on the magnitude and nature of the penalty involved.
Lenders allocate budgetary allowances for expected returns based on interest payments over the loan term. Pre-payment prevents them from getting higher returns because they will not have to work with higher interest rates due to early returns of the principal amount.
2026 Market Insights:
As a consequence of this instability in the economy and with forecasts of interest rate fluctuations continuing in 2026, lenders have become increasingly prudent in their lending practices and have turned to prepayment penalties.
Soft Penalty: Borrowers are allowed to sell the collateral without incurring a penalty but with a refinance.
Hard Penalty: The penalty will be charged in case of prepayment, which might be because of sale or refinance.
Calculation Methods:
Fixed Amount: A fixed amount such as $5,000.
Percentage of Loan Balance
This cost will reduce with time, such as 5% in year one, dropping each year.
Percentage of Interest: Tied to a part of the outstanding interest payments due, such as 75% of the interest in 12 months.
A characteristic of Commercial Mortgage-Backed Securities (CMBS) lending, “defeasance” involves prepaying a mortgage with a portfolio of Treasury obligations with returns equal to those of the interest in the remaining life of a mortgage. While defeasance shields investors in a mortgage-backed security, it can be very expensive when accomplished before a mortgage is repaid.
Yield maintenance protects a lender from a decrease in interest income when a borrower fails to make payments. Yield maintenance can be calculated if the present value of payments owed on a loan is measured against the income on a Treasury or other comparable instrument.
Prepayment Clauses Under Scrutiny: Some state regulators and consumer advocates have called for increased prepayment notice and limits on the level of prepayment penalties in an attempt to better protect consumers.
Technology-Driven Loan Servicing
Advanced technology-driven systems have enabled more accurate calculations of prepayment charges, and borrowers can evaluate these charges in real time.
Green Financing Incentives: A growing number of lenders in 2026 will begin waiving or reducing prepayment charges for borrowers taking out refinance loans in order to implement energy-efficient solutions.
Profitable Sale of a Property at a Significant Profit: Although a penalty will have to be paid, a lucrative profit may make it worthwhile to repay a loan early.
Refinancing for Savings of Interest: When refinancing saves interest with a lower rate, which in turn saves money over a fixed time, it is justifiable to make a payment.
Prepayment Penalties
A prepayment penalty is a charge your lender imposes if you repay a loan before the end of the predetermined term. Your lender may charge you a prepayment penalty if you refinance a loan because of a better interest rate, if you sell your property early, among other reasons. As of 2026, prepayment penalties remain prevalent in multifamily and commercial loans, particularly with fixed-rate debt.
A predictable series of interest payments is how lenders structure their loans. With early payoff, lenders will have a reduced and uncertain return, which they can invest in another product. Prepayment penalties shield this return and make it simpler for lenders to estimate a loan’s pricing in an uncertain interest rate environment in 2026.
Yes. Even in their adjustment to rate shocks over the last years, prepayment penalties have remained a common part of lending in multifamily and commercial mortgages. They appear most frequently in fixed-rate, CMBS, and agency loans, or in any transaction where a fixed capital commitment is being locked in by a lender.
Soft prepayment penalty: You can transfer your ownership without any charge, but if you refinance your purchase, you will be charged a prepayment penalty. A hard prepayment penalty charges you regardless of whether you refinance your purchase or you’re selling it. A hard prepayment penalty gives you less flexibility in exit options but with a better rate of interest.
Usually, you will notice one or more of the following:
Fixed dollar amount – A flat rate charge (for example, $5,000).
Percentage of outstanding balance – Usually a step-down schedule (5% in year one, 4%, 3%, and so on).
Percentage of remaining interest – A part of your interest payments over a fixed time, such as the next 6-12 months.
With larger commercial loans, you need to watch out for defeasance or yield maintenance clauses, which are used to protect the bondholders’ yield or the bond’s interest rate.
Defeasance remains a prevalent practice in CMBS lending in 2026. Although it does not actually “repay” the debt, you can think of it this way: you replace this payment stream with a new portfolio of Treasury or similar obligations with an equivalent cash flow. While this preserves your income commitments to your bondholders, it can become very complicated and expensive if you do it early in your term.
Yield maintenance is a prepayment structure in which you can repay your loan so that you will have earned exactly as much if you had simply retained your money in your own loan. The prepayment charge computes based on the present cost of additional payments in contrast with additional investment opportunities available in treasuries. A case where lower interest is higher than your interest attracts a rather high cost in yield maintenance.
Prepayment penalties in 2026 will follow a few trends in their appearance in these transactions:
“Regulatory pressure & transparency − Some states and regulators are pushing for greater disclosures and more borrower-friendly terms, especially with smaller multifamily and residential loans,”
Improved tech & modeling tools – Better lending servicing technology enables a borrower to estimate prepayment penalties in real time, making it simpler to project different dates of exit or refinance.
“Green” and impact-driven refinance incentives – Ever more lenders are receptive to lowering or forgoing charges in exchange for your refinance into borrowings linked with energy efficiency or ESG-positive upgrades.
It can. Loans with better prepayment protection sometimes will have lower interest rates or better front-end terms because they provide a more predictable income stream for lenders. A reasonable prepayment penalty period may very well be a trade-off for investors in a higher-risk product.
Penalization by payment or agreement can be sensible in situations such as:
They see you’re making a healthy profit and that the net profit dwarfs your expense.
Refinancing into significantly better debt and interest savings are greater than the hit, which makes your financial situation better.
Your portfolio is being repositioned in 2026, and this will unlock equity for better investment, risk reduction, and/or loan consolidation.
The trick is to do the math: total penalty & cost vs. projected savings/profits.
“You or your advisor should model:”
The total prepayment penalty and closing cost
The new interest rate, amortization, and payment
“The breakeven point—how long it takes for savings to exceed the penalty,”
Before closing on a 2026 loan, you’ll want to ask Is it a hard or soft punishment, and for how many years? Is it a step-down, yield maintenance, defeasance, or fixed fee structure? Could you provide example calculations for prepayments in years 2, 3, 5, and beyond? Are there exceptions or reductions (partial paydowns, green upgrades, interest-rate resets)?) Having clear answers to these important questions can help you negotiate better, plan your exits, and avoid costly surprises when you do decide to sell or refinance.
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