What is a Step-Down Prepayment Penalty?
A step-down is one kind of a prepayment penalty on an existing commercial mortgage or other commercial property loan. Lenders typically impose a prepayment penalty on all financial products that create a creditor-debtor relationship. As the creditor, the lender relies on the terms of the original loan to predict a return on investment.
As insurance against that loss of revenue, commercial mortgage lenders may include a step-down clause in the mortgage contract. Generally, this is a straightforward calculation based on the remaining balance. It is called a "step-down" penalty because the amount gets smaller the longer the loan is in place.
For example, a typical step-down might be 5 % of the outstanding balance in the first year, 4% in the second year, 3% in the third year, and so on. Most lenders will not charge a step-down penalty in the last 90 days of the loan term.