**Last edited:** May 1, 2024

 

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## What is a Prepayment Penalty?

 

If you are a rental property investor shopping for a [DSCR loan](https://www.offermarket.us/blog/dscr-loan), you have probably come across the concept of a prepayment penalty. A pre payment penalty is a fee charged to the borrower for paying off the loan during a specified period of time. 

 

## Why do lenders charge a prepayment penalty?

 

Private lenders charge a pre-payment penalty to avoid a scenario where a loan is originated and then quickly paid off through a refinance or sale. In exchange for a competitive interest rate, the lender is looking to secure a longer duration of interest payments. 

 

Let's take a moment to review common pre-payment penalty options and share insights to help you choose the best option for your next financing. 

 

## Do lenders charge a prepayment penalty for fix and flip loans?

 

You should not be charged a prepayment penalty for short term interest only loans (i.e. fix and flip, bridge, construction, hard money). Some lenders charge a 1% fee on the back end of the loan which we think is a cheap shot "junk fee". If you have a 12 month term on a fix and flip loan, and you're out of the loan by month 6, via sale or refinance, then you should not have to pay any additional penalty or interest. You should only pay interest for the time you held the loan.

 

## 5-4-3-2-1 Prepayment Penalty

 

A **5-4-3-2-1 prepayment penalty**, otherwise known as a 5 year stepdown prepayment penalty, charges a 5% fee on the outstanding principal loan balance if the loan is paid off in year 1, a 4% fee in year 2, a 3% fee in year 3, a 2% fee in year 4, and a 1% fee in year 5. If the loan is paid off in year 6, there will be no prepayment penalty. 

 

The 5-4-3-2-1 prepayment penalty option carries a slightly lower interest rate than other pre payment penalty options, typically by 0.15% compared to the 3-2-1 prepayment penalty option, and is particularly popular among buy and hold rental investors during times of low interest rates.

 

## 3-2-1 Prepayment Penalty

 

A **3-2-1 prepayment penalty**, otherwise known as a 3 year stepdown prepayment penalty, charges a 3% fee on the outstanding principal loan balance if the loan is paid off in year 1, a 2% fee in year 2, and a 1% fee in year 3. If the loan is paid off in year 4, there will be no prepayment penalty. 

 

The 3-2-1 prepayment penalty option carries a slightly higher interest rate than the 5-4-3-2-1 option, typically 0.15%, and is particularly popular during times of elevated interest rates, because the borrower will be able to cost effectively refi after only a few years. The 3-2-1 pre payment penalty is the most popular option among clients of OfferMarket Capital. 

 

## 2-1 Prepayment Penalty

 

A 2-1 prepayment penalty is a carries a slightly higher interest rate than the 3-2-1 prepayment penalty, typically 0.125%.

 

## 3-0 Prepayment Penalty

 

A **3-0 prepayment penalty**, charges a 3% fee on the outstanding principal loan balance if the loan is paid off in year 1, and no prepayment penalty thereafter. The 3-0-0 prepayment penalty option carries a higher interest rate than the 5-4-3-2-1 option, typically 0.4%, and is worth considering if you want to have a cost effective option to sell or refinance after the first year. 

 

## 1-0 Prepayment Penalty

 

A **1-0-0 prepayment penalty**, charges a low 1% fee on the outstanding principal loan balance if the loan is paid off in year 1, and no prepayment penalty thereafter. The 1-0-0 prepayment penalty option carries the highest interest rate compared to the 5-4-3-2-1 option, typically 0.65%. Like the 3-0-0 option, this is only worth considering if you expect to sell or refinance the property soon after the loan is originated. Many private lenders will require loan committee approval to offer this option, since the borrower may be trying to use this option instead of a short term bridge loan which typically carries a considerably higher interest rate. 

 

## No Prepayment Penalty DSCR Loan

 

Some DSCR lenders, including OfferMarket, offer a no prepayment penalty option. It is also important to note that certain states such as Pennsylvania and Ohio do not allow prepayment penalty for loans below a certain amount. In cases where there is no prepayment penalty, you can either expect a higher interest rate, or an upfront lender fee charged on the settlement statement. 

 

In our core DSCR loan, in states that do allow prepayment penalty, the interest rate for no prepayment penalty is the same as the 5-4-3-2-1, however there will be a 1.125% lender fee added to the settlement statement. In scenarios where the state does not allow a prepayment penalty, we are able to offer a slightly higher interest rate (~0.25%) and/or a low additional lender fee typically not higher than 0.625% of the loan amount.

 

## Extra payments on DSCR Loan

 

Many borrowers do not realize that partial prepayment of principal during the prepayment penalty period are subjected to a penalty fee. So, if you have a 5-4-3-2-1 prepayment penalty clause, and you make a $1,000 additional payment towards your principal loan balance during year 1, you will be charged a 5% fee of $50. 

 

## Prepayment Penalty for Fix and Flip Loan

 

While pre payment penalties are a standard term for DSCR loans, they are not common for short term fix and flip loans. 

 

## Instant DSCR Loan Quote and Pre-Approval

 

Our friendly and knowledgeable relationship managers are always happy to review loan requests and help you select the best pre payment penalty option for your real estate investing goals. For instant DSCR loan quotes and pre-approval, visit [OfferMarket Capital](https://www.offermarket.us/loans).

A prepayment penalty is a fee charged by a lender when the loan is repaid within a designated period of time. Prepayment penalties are common for DSCR loans from private lenders.

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## What does non-recourse mean?

 

**Non-recourse** refers to a type of loan agreement where the lender can only look to the collateral pledged as security for the loan in case of default, and not to the borrower personally, for recovery of the debt. This means that in the event of default, the lender cannot seek payment or recovery from the borrower's personal assets or income.

 

## Non-recourse loan interest rates

 

Non-recourse loans are typically priced at a higher interest rate than recourse loans in order to compensate the lender for accepting less security of principal. Lenders may also require a higher DSCR in order to qualify for a given loan-to-value or LTV.

 

## Are DSCR loans non-recourse?

 

Not all DSCR loans are non-recourse. In fact, most private lenders require or strongly prefer full recourse. Loan programs that are non-recourse commonly include a [pledge of shares agreement](https://www.offermarket.us/real-estate-glossary/pledge-of-shares) and [bad boy carve outs](https://www.offermarket.us/real-estate-glossary/bad-boy-carve-outs).

 

### 1 - 4 Unit DSCR Loans

 

Most DSCR loan programs for 1-4 units require full recourse. This means that at least one member of the borrowing entity, typically an LLC, serves as a personal guarantor for the life of the loan.

 

### Portfolio DSCR Loans

 

Portfolio DSCR loans of 2 or more 1-4 unit properties can be either full recourse or non-recourse. 

 

### Multifamily DSCR Loans

 

Likewise, multifamily DSCR loans for 5+ unit properties can be either full recourse or non-recourse.

 

Ultimately, whether a loan is recourse or non-recourse depends on the type of loan and the risk tolerance of the lender and borrower.

 

The terms of the loan agreement will determine whether a DSCR loan is recourse or non-recourse, and the decision will depend on various factors, including the creditworthiness of the borrower, the type of collateral pledged as security, and the lender's risk tolerance.

 

## What's the difference between recourse and non-recourse loans?

 

A recourse loan is a type of loan or financing agreement where the borrower is personally liable for repayment of the debt, and the lender has the right to seek repayment from the borrower's personal assets or income in the event of default. This means that the lender has a claim not only on the collateral pledged as security for the loan, but also on the borrower personally.

 

A non-recourse loan, on the other hand, is a type of loan where the borrower is not personally liable for repayment of the debt in the event of default. The lender's only remedy in the event of default is to foreclose on, or seize, the collateral pledged as security for the loan, and not to seek repayment from the borrower personally.

 

In general, non-recourse loans are considered to be less risky for the borrower, but they also typically come with stricter terms and higher interest rates to compensate the lender for the increased risk.

 

## Are fix and flip loans non-recourse?

 

While it depends on the lender, most fix and flip loans are recourse and therefore require a personal guarantor.

 

## Why do lenders require personal guarantee?

 

Lenders require a personal guarantee from borrowers as a way to secure their investment in case of default on a loan. A personal guarantee is a commitment from the borrower to repay the debt using their personal assets or income if the borrower's business is unable to repay the loan.

 

Lenders ask for personal guarantees because it provides them with added protection and security in the event that the borrower's business is unable to repay the loan. This helps the lender to recover their investment even if the borrower's business fails or goes bankrupt. Personal guarantees also give lenders a way to enforce repayment if the collateral pledged as security for the loan is not sufficient to cover the debt.

 

In general, lenders require personal guarantees when the borrower has a limited credit history or when the loan amount is large and the collateral is inadequate to secure the debt.

Non-Recourse in lending means there is no personal guarantee.

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Non-Recourse | OfferMarket Real Estate Glossary

Non-Recourse

**Last updated:** April 15, 2024

 

Many rental property investors are surprised to learn that the vast majority of DSCR lenders require the borrowing entity to be an LLC or Corporation because DSCR loans are business purpose loans. Since LLCs are the most commonly used entity to own real estate, nearly all DSCR loans are given to LLCs. It is very uncommon for DSCR lenders to allow title to be held in personal name and it is easy to transfer title from your personal name to an LLC in order to obtain a DSCR loan for your rental property.

 

*Don't have an LLC?* *Have an LLC but aren't sure which documents you need for a DSCR loan?* This article will be your guide.

 

## DSCR LLC Checklist

 

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<table>
<thead>
 <tr>
 <th>LLC Item</th>
 <th>Required</th>
 </tr>
</thead>
<tbody>
 <tr>
 <td>Articles of Organization</td>
 <td>Yes</td>
 </tr>
 <tr>
 <td>Operating Agreement</td>
 <td>Yes</td>
 </tr>
 <tr>
 <td>Certificate of Good Standing</td>
 <td>Yes</td>
 </tr>
 <tr>
 <td>Foreign Entity Registration</td>
 <td>If LLC and property are different states</td>
 </tr>
 <tr>
 <td>IRS EIN Letter or Form W-9</td>
 <td>Yes</td>
 </tr>
</tbody>
</table>
</div>

 

## Articles of Organization

 

Articles of Organization is a legal document that is filed with the appropriate state authority (usually Secretary of State) to formally establish a limited liability company (LLC). The Articles of Organization essentially serve as the LLC's "birth certificate" and provide essential information about the business. The specific name and requirements for filing Articles of Organization can vary by state, as LLC formation is governed by state law in the United States.

 

**Information typically included in the Articles of Organization:**

 

1. **Name of the LLC:** The legal name of the LLC, which must comply with the naming rules of the state. The state will make sure that name is available and you will need to choose exactly how you want the "LLC" component of the name to be formatted -- 'LLC', ", LLC', 'L.L.C.', ', L.L.C.', 'Limited Liability Company'.
2. **Principal Place of Business:** The physical address where the LLC conducts its primary business operations.
3. **Registered Agent:** The name and address of a registered agent, who is a person or entity designated to receive legal documents on behalf of the LLC. This person or entity must have a physical address within the state of formation. The registered agent is most commonly a member of the LLC, a lawyer, or a professional registered agent service.
4. **Purpose of the LLC:** A general statement about the purpose of the LLC. In many cases, this is a broad statement indicating that the LLC is organized for any lawful business purpose.
5. **Duration of the LLC:** Some states require specifying whether the LLC is formed for a specific duration or whether it is perpetual.
6. **Management Structure:** Some states may require disclosure of whether the LLC will be member-managed or manager-managed.
7. **Organizer Information:** The name and address of the person or entity responsible for filing the Articles of Organization. This is often an individual associated with the LLC or a professional filing service.

 

Once the Articles of Organization are prepared and submitted to the state, and the required filing fee is paid, the state reviews the document. If everything is in order and complies with state regulations, the state issues a Certificate of Organization or a similar document, officially recognizing the LLC's existence. It typically takes less than 30 minutes to register your LLC online directly with the state (not through a business registration service), and less than 2 weeks to receive your Articles of Organization. While processing speed depends on state and registration volume, it is most common to receive your Articles of Organization in 1-5 business days. 

 

It's important for business owners to understand and adhere to their state's specific requirements for filing Articles of Organization, as the process can vary. Additionally, some states may refer to this document by different names, such as a **Certificate of Formation** or a **Certificate of Organization**.

 

DSCR lenders do not require LLC "seasoning". In other words, you do not need to have an LLC that was already registered in order to [apply for your DSCR loan](https://www.offermarket.us/loans?ref=blog-dscr-loan-for-llc) and begin processing. You can simultaneously apply for a DSCR loan and register your LLC. We call this a "To Be Formed LLC" or "To Be Formed Entity".

 

## Operating Agreement

 

An operating agreement is a legal document that details the internal structure, management, and operation of your LLC. While an operating agreement is not required by law, it is required by DSCR lenders. An operating agreement it is certainly a best practice for all businesses as it establishes a strong foundation and expectations concerning the business' purpose and how it will be managed.

 

Components typically addressed in an operating agreement include:

 

1. **Organization and Structure:** Describes how the LLC is organized, its name, location, and the duration of its existence.
2. **Members' Rights and Responsibilities:** Outlines the rights, responsibilities, and voting powers of the LLC members (owners).
3. **Management Structure:** Defines how the LLC will be managed, specifying whether it will be member-managed (members make decisions) or manager-managed (appointed managers make decisions).
4. **Distribution of Profits and Losses:** Specifies how profits and losses will be allocated among the members.
5. **Transfer of Membership Interest:** Outlines the process and conditions for transferring ownership interests in the LLC.
6. **Dissolution:** Describes the procedures for dissolving the LLC and distributing its assets if the need arises.
7. **Dispute Resolution:** Addresses how disputes among members will be resolved.
8. **Meetings and Voting:** Details the frequency and procedures for meetings, as well as the voting requirements for decision-making.

 

Having a thoughtfully drafted operating agreement is crucial for the smooth functioning of an LLC and can help prevent conflicts by providing a clear framework for decision-making and dispute resolution. It is often created at the time of the LLC's formation, and all members typically sign it.

 

Common issues we see when processing DSCR loans for LLCs:

 

- **One or more missing signatures** -- make sure all members of the LLC sign and date the operating agreement.
- **Missing membership percentage** -- make sure the agreement includes a table that shows how much ownership each member has in the LLC.

 

## Sample Operating Agreement for Rental Property

 

To streamline your borrowing experience, if you do not have an operating agreement, we are happy to provide you with our template which is specifically drafted for LLCs whose purpose is to own and manage rental properties:

 

- [TEMPLATE - Single Member LLC Operating Agreement](https://docs.google.com/document/d/1lhBk_EvwFBVQrV9xNhEelgKrfEETk4UlpAWh_N8m1es/edit?usp=sharing)
- [TEMPLATE - Multi-Member LLC Operating Agreement](https://docs.google.com/document/d/1oAd52NWg6BfEMZ-FmHrThckyuwDAYi61/edit?usp=sharing&rtpof=true&sd=true)

 

## Certificate of Good Standing

 

A Certificate of Good Standing, also known by various names such as a Certificate of Existence, Certificate of Status, Certificate of Fact, or Certificate of Compliance, is an official document issued by a state government or relevant authority. This certificate confirms that a business entity, such as a corporation or a limited liability company (LLC), is in compliance with the statutory requirements and is authorized to do business in that state.

 

If your LLC is older than 1 year, your DSCR lender will need a Certificate of Good Standing, or COGS for short which is used to confirm the following:

 

1. **Active and in Good Standing:** The certificate typically verifies that the business is active and in good standing with the state. "Good standing" means that the business has met its ongoing filing requirements, such as submitting annual reports and paying required fees.
2. **Legal Existence:** It confirms the legal existence of the business entity. This is important for entities operating in multiple states or seeking to engage in certain transactions that require proof of good standing.
3. **Compliance with State Requirements:** The certificate indicates that the business has complied with all state regulations, including filing annual reports, paying taxes, and maintaining a registered agent.
4. **Authorization to Conduct Business:** For businesses that operate in multiple states, a Certificate of Good Standing may be required to demonstrate that the entity is authorized to conduct business in a particular state.
5. **No Pending Dissolution:** It confirms that there are no pending dissolution proceedings or any other issues that would jeopardize the entity's ability to continue its operations.

 

If your LLC will own rental properties in another state, the state in which the rental property is located may require a Certificate of Good Standing in order to register a your LLC in that state as a "Foreign Entity".

 

Many states allow you to obtain your Certificate of Good Standing by filling out a simple online form on the state's website. In order to receive the Certificate of Good Standing, you need to make sure your LLC has filed its annual report. The Certificate of Good Standing is typically received same day for a small fee ranging from $5 to $40 depending on the state.

 

## Foreign Entity Registration

 

If your LLC is registered in a state that is different from the state where the rental property is located, you will need to obtain a Foreign Entity Registration. This is a simply an official document that acknowledges that you have notified the state in which the rental property is located that your out-of-state ("foreign") LLC will be doing business in their state.

 

## IRS EIN Letter

 

The IRS EIN Letter is an official document from the IRS that confirms the Employer Identification Number assigned to your LLC. If you do not have an IRS EIN assigned to your LLC, you can [register directly on the IRS website](https://www.irs.gov/businesses/small-businesses-self-employed/apply-for-an-employer-identification-number-ein-online).

 

## IRS Form W-9 

 

If you have an IRS EIN but you have misplaced the EIN Letter, you can simply fill out [IRS Form W-9](https://www.irs.gov/pub/irs-pdf/fw9.pdf) and provide it to your lender. The Form W-9 is a request for taxpayer identification number and certification that the information is accurate.

 

The IRS EIN Letter or W-9 needs to be on file with your lender so that your Form 1098 annual mortgage statement can be provided to you and filed with the IRS. When you have a DSCR loan, the servicer assigned to your loan will provide you with Form 1098 generally in January or February. This form indicates how much you have paid in interest in the preceding year and you or your accountant will use it when filing taxes as mortgage interest is tax deductible.

 

## Multi-Member LLC

 

If you have multiple members (owners) in your LLC, it is important to understand how each member's credit score will affect your terms and ability to meet DSCR loan guidelines. OfferMarket's DSCR loan program requires 51% of the membership interest in the LLC to serve as personal guarantor. So, if your LLC has two members, each with 50% ownership, each member will need to be a guarantor. When there are more than one guarantors, the credit score of the guarantor with the lowest credit score will be used to confirm terms. This can negatively impact the max LTV and highlights the importance of structuring your LLC membership and ownership so that 51%+ ownership is associated with high credit score members.

LLC is the standard borrowing entity for a DSCR loan. This article with guide you through all aspects of processing and underwriting your LLC borrowing entity when applying for a DSCR loan.

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DSCR Loan for LLC

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### What is foreclosure?

 

When a borrower has stopped making payments to a lender, foreclosure is the legal process in which a lender attempts to recover the balance of a loan from the borrower by forcing the sale of the asset (real estate) used as the collateral for the loan.

Foreclosure is the legal process in which a lender attempts to recover the balance of a loan from a non-performing borrower by forcing the sale of the asset (real estate) used as the collateral for the loan.

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