Soft Step Downs as a prepayment penalty In Commercial Property Loans
During the life of a commercial loan, the prepayment penalty may decrease over time as the lender earns interest income and recoups principal balance. Among the different prepayment penalty options of commercial loans, are yield maintenance and defeasance requirements, which essentially replace the original financial benefit to the lender, while discharging borrowers early from their mortgage obligations.
For borrowers who anticipate difficulties meeting the financial obligations of those aforementioned prepayment options, lenders may agree to step down clauses in mortgage contracts. A step down requires the payment of a set percentage of the outstanding amount of the loan. That percentage declines as the loan ages. While a typical step down might decline by 1% a year, for example 5 % in year one, 4 % in year two and 3 % in year three, a soft step down starts at a lower rate and declines less quickly. While a step down might have terms that equate to 5-4-3-2-1, a soft step down might be 3-2-2-1-1.