In one sentence
A prepayment penalty that declines over time, such as 5% in year one falling by a point each year.
The longer version
Step-down structures make early payoff progressively cheaper, giving borrowers a predictable path to prepay. A 5-4-3-2-1 structure charges 5% in year one down to 1% in year five.
Step-downs are simpler than yield maintenance or defeasance, and common on balance-sheet loans where the lender wants prepayment protection without complexity.
Common questions
- How does a step-down prepayment penalty work?
- The penalty is a percentage of the prepaid balance that declines each year, for example 5 percent in year one, 4 percent in year two, and so on.
- When is the step-down penalty calculated?
- At the time of prepayment, using the percentage for that loan year applied to the balance being repaid.
- How does a step-down compare to yield maintenance?
- A step-down is simple and predictable. Yield maintenance varies with interest rates and can be much higher or lower depending on the market.
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