Prepayment penalties are fees that lenders charge when a borrower pays back their loan before the end of its term. These penalties can be applied to all types of loans, including agency debt, which is debt issued by certain government-sponsored entities such as Fannie Mae and Freddie Mac. If you’re a real estate investor considering taking out an agency debt loan, it’s important to know about the different prepayment penalty options available so you can make an informed decision. Let’s take a look at what you need to know.
Types of Prepayment Penalties for Agency Debt Loans
The most common type of prepayment penalty for agency debt loans is called a yield maintenance penalty. This type of penalty requires borrowers to pay the lender an amount equal to the difference between the original interest rate and current market rate on the loan amount being repaid early. For example, if you took out a loan with an interest rate of 5%, but current market rates were 3% when you paid off your loan early, then you would owe the lender 2%.
Another option is called a defeasance clause or defeasement provision. With this type of prepayment penalty, borrowers must purchase U.S. Treasury securities in order to make up any lost revenue due to early repayment. These Treasury securities must have maturities and yields that match the remainder of your loan payments in order for your lender to get compensated for lost revenue without requiring a yield maintenance penalty payment from you.
Defeasance clauses are usually more expensive than yield maintenance penalties because they require borrowers to spend extra money on Treasury securities rather than just paying the difference between their original interest rate and current market rates in cash. However, these clauses can be beneficial because they allow borrowers to remove any restrictions put in place by their lender—such as lien rights—which may be necessary if they plan on refinancing or selling their property later down the line.
One other option is step down prepayment penalty where the penalty is expressed as a percentage of the loan balance. This percentage generally decreases over time. A typical step down prepayment penalty for say a 7 year loan might be 5%, 5%, 4%, 4%, 3%, 2% and then 1%. Step down prepayment penalties offer investors a predictable prepayment penalty which helps to develop the proper exit strategy.
Prepayment penalties are one thing that real estate investors should consider before taking out an agency debt loan. There are two main types of prepayment penalties: yield maintenance penalties and defeasance clauses (or defeasement provisions). Yield maintenance penalties require investors to pay lenders an amount equal to the difference between their original interest rate and current market rates while defeasance clauses require them to purchase U.S Treasury securities as compensation for lost revenue due to early repayment. Knowing about these different options will help investors determine which is best suited for their individual needs so that they can make an informed decision when it comes time to take out their agency debt loan.
To learn more about real estate investing and syndications, reach out to us at https://investwithspark.com/contact/ today!