The Real Estate Capital Institute®

Seven Rules of Effective Prepayment Penalty Negotiations - Getting the Right Loan Terms

Debt Term Needs to Match Sponsorship Operating Objectives


Chicago, IL -- (ReleaseWire) -- 12/18/2007 -- Prepayment penalties can be substantial to borrowers, as well as attractive profit protection for lenders. Borrowers need flexibility, while lenders seek yield preservation.

Prepayment language is more important today, as the yield curve favors long-term debt with better pricing and terms than shorter maturities. All being equal other than term, the major difference between notes rests within the prepayment calculations.

Nearly all short-term loans of five years or less have liberal prepayment penalties, and occasionally, none. Long-term debt is often burdened by the prepayment penalties that can cost as much as 10% or more of the loan balance, depending on the formula used.

Some overall rules about prepayment penalties are as follows:

1) Usually locked out from prepayment during first half of the term
2) Negotiable if coupon rate is substantially below current market rate
3) Minimum penalty typically at one percent
4) Yield-maintenance formula works best for borrowers expecting lower rates later in the term
5) Declining Balance formula provides calculated certainty in loan payoffs
6) Defeasance formula requires costly processing and multiple approvals - more applicable for locked cash flow loans (e.g., long-term, net lease properties)
7) Types of funding sources have a direct correlation on prepayment formulas (e.g., balance sheet lender has more flexibility than lender intending to sell the note)

Nat Zvislo, Research Director of the Real Estate Capital Institute® states "Prepayment penalties should closely match the borrower's holding term and operating objectives." Adding, “The premium negotiated is often the difference between a ‘good’ loan and a ‘great’ loan.”

The Real Estate Capital Institute® is a volunteer-based research organization tracking debt and equity rate data. The Institute posts daily and historical rates including treasuries and short-term rates. The Real Estate Capital RateLine 7RE-CAPITAL (773-227-4825) provides hourly updates.