Commercial Loan Prepayment Penalties: What Paying Off Early Costs

A commercial real estate loan is priced as a stream of interest payments over a set term. Pay it off early and the lender loses part of that stream — so most commercial loans make you pay for the privilege. The charge ranges from nothing at all to more than 10% of the loan balance, depending on how the prepayment clause is written and where interest rates are when you pay off.

If you might sell, refinance or pay down the property before the loan matures, the prepayment clause can matter as much as the interest rate. This guide explains the four structures you'll see, shows what each one costs on the same loan, and covers how to plan around them.

Why Commercial Lenders Charge Prepayment Penalties

Residential mortgages can almost always be repaid early without cost. Commercial loans are different because of how they are funded. A life insurance company matches its loans to long-term obligations. A CMBS loan is pooled into bonds sold to investors who were promised a set stream of payments. Fannie Mae and Freddie Mac multifamily loans are securitized the same way. When a borrower repays early, those investors have to reinvest the money — usually at a lower rate — and the prepayment clause compensates them.

Banks and credit unions hold most of their loans on their own books, so their penalties tend to be simpler and smaller. Bridge and hard money lenders often charge little or nothing, because they expect to be repaid early.

1. Step-Down (Declining) Prepayment Penalties

A step-down penalty is a fixed percentage of the balance being prepaid that falls each year. The most common schedule on a five-year loan is 5-4-3-2-1: 5% of the prepaid balance in year one, 4% in year two, and so on. Shorter schedules such as 3-2-1 are also common.

Example: a $3,000,000 balance repaid in year two of a 5-4-3-2-1 schedule costs 4% — $120,000. Wait until the first day of year three and it costs $90,000.

Step-downs are easy to plan around because the cost is known in advance and does not depend on interest rates. You'll see them most often on bank, credit union and some debt fund loans.

2. Yield Maintenance

Yield maintenance charges you what the lender loses by reinvesting your payoff at today's Treasury yield instead of collecting your note rate for the rest of the term. In simplified form:

Penalty ≈ present value of (note rate − Treasury yield) × balance, for each remaining month

The key point is that the cost moves with interest rates. When Treasury yields have fallen below your note rate, yield maintenance is expensive. When yields have risen to your note rate or above it, the formula produces little or nothing, and you pay only the minimum in the note — often 1% of the balance.

Example: $3,000,000 balance, 6.75% note rate, five years remaining. Using our yield maintenance calculator:

• Treasury yield at 4.00%: penalty of about $373,000 (12.4% of the balance)
• Treasury yield at 5.50%: about $164,000 (5.5%)
• Treasury yield at 6.75% or higher: the formula gives $0, so the note's minimum applies

For reference, the 10-year Treasury was 5.18% and the 5-year 5.03% in September 2026. Many yield maintenance clauses use the Treasury whose maturity is closest to the remaining term — check your note, then enter that yield in the calculator.

Yield maintenance is common on life insurance company loans, on many fixed-rate Fannie Mae and Freddie Mac multifamily loans (some agency loans defease instead), and on some CMBS loans. The exact formula varies by note — which Treasury is used, whether a spread is added to it, whether the loan's scheduled amortization is included — so treat the calculator as an estimate and ask the servicer for a payoff quote before you commit to a sale or refinance.

3. Defeasance

Defeasance is the usual prepayment method for CMBS loans. You don't technically repay the loan. Instead, you buy a portfolio of U.S. Treasury (or agency) securities whose payments match the loan's remaining payments, and that portfolio replaces the property as collateral. The loan stays in the CMBS pool, owned by a successor borrower, and your property is released.

The cost has two parts:

• The securities premium — what the bond portfolio costs above your loan balance. Like yield maintenance, it is larger when Treasury yields are below your note rate.
• Transaction fees — the defeasance consultant, legal counsel on both sides, the servicer, the successor borrower and sometimes rating agency confirmations. These are real money even when rates have risen.

Example: the same $3,000,000 loan at 6.75% with five years remaining and Treasuries at 4.00%. Our defeasance calculator estimates a securities premium of about $206,000. Add an assumed $40,000 in fees and the total is about $246,000 (8.2%) — less than the yield maintenance figure above, because the portfolio only has to replace the payments the loan actually has left, including amortization. Actual defeasance costs depend on the loan's exact payment schedule and are quoted by a defeasance consultant.

Defeasance takes planning: expect several weeks, and budget for the fees whether or not rates are in your favor. Many CMBS loans also have a lockout period at the start of the term — commonly around two years — during which the loan cannot be prepaid or defeased at all. See our guide to CMBS loans for how these loans are structured.

4. SBA Loan Prepayment Rules

SBA loans follow federal rules rather than a lender's own schedule.

SBA 7(a): a prepayment fee applies only when all three of these are true — the loan has a maturity of 15 years or more, you prepay voluntarily, and the prepayment is more than 25% of the outstanding balance within the first three years. The fee is 5% of the amount prepaid in year one, 3% in year two and 1% in year three. After year three there is no SBA fee. (13 CFR 120.223.) Most 7(a) loans for real estate have 25-year terms, so the rule usually applies to them.

SBA 504: the CDC portion of a 504 loan (the SBA-backed debenture, typically 40% of the project) carries a declining prepayment penalty for the first half of the term. On a 20- or 25-year debenture it lasts ten years, starting at roughly one year's interest on the debenture balance and falling about 10% each year. On a 10-year debenture it lasts five years. After that the debenture can be repaid without penalty. The bank's first mortgage in a 504 loan is a separate loan with its own prepayment terms, set by the bank — read both.

The Four Structures Side by Side

• Step-down — cost known in advance; does not depend on rates; typically 1–5% of the balance. Bank, credit union and some debt fund loans.
• Yield maintenance — cost rises as Treasury yields fall below your note rate; can exceed 10% early in the term; minimum often 1%. Life company, agency and some CMBS loans.
• Defeasance — securities premium moves like yield maintenance, plus fixed transaction fees; slower and more complex. Most CMBS loans.
• SBA — set by federal rules: 5-3-1% for qualifying 7(a) prepayments, a ten-year declining penalty on the 504 debenture.

Planning a Refinance or Sale Around the Penalty

Know the number first. Get the penalty from the note and a payoff quote from the servicer. Then check whether the refinance still pays for itself with our refinance breakeven calculator — a lower rate that saves $4,000 a month takes more than seven years to earn back a $373,000 penalty.

Time it. A step-down penalty drops on each loan anniversary; closing a few weeks later can save a full percentage point. Most commercial notes also have an open period near maturity — often the last three to six months — when the loan can be repaid at no cost.

Consider an assumption. Many CMBS and agency loans can be assumed by a buyer, with the lender's approval and an assumption fee. When the penalty is large, selling the property with the loan in place can cost far less than paying it off.

Negotiate at the start. The best time to deal with a prepayment penalty is before you sign. Ask whether a step-down is available instead of yield maintenance, whether the penalty period can be shorter than the loan term, and whether you can prepay part of the balance each year (10–20% is a common allowance) without penalty. Expect to pay for flexibility with a slightly higher rate.

Questions to Ask Before You Sign a Term Sheet

• What type of prepayment penalty applies — step-down, yield maintenance, defeasance or a flat fee?
• How long does it last, and is there a lockout period?
• For yield maintenance: which Treasury yield is used, is there a minimum, and is it calculated on the full balance or the scheduled payments?
• When does the open period start?
• Can I prepay part of the balance each year without penalty?
• Is the loan assumable by a buyer, and on what terms?
• For an SBA 504 loan: what are the prepayment terms on the bank's first mortgage?

Prepayment terms are one of the things we compare across lenders when we look at a deal, alongside rate, leverage and recourse. If you're planning a refinance or a purchase and want to know how the prepayment terms on your options compare, submit a commercial real estate loan application or read how commercial real estate refinancing works.

💡 Paying off a loan with a large penalty? Model it first with the yield maintenance and defeasance calculators, then see how we compare lenders.

Sources: SBA 7(a) prepayment fee — 13 CFR 120.223. SBA 504 debenture prepayment — summaries published by Certified Development Companies, e.g. Growth Corp and Business Lending Partners. Worked examples use BestLoanUSA's calculators and are estimates; your note and servicer's payoff quote govern.