Higher rate with 1% pre-pay penalty vs lower rate with 5% yearly decreasing penalty

[Juan Lizarazo]

Hello beautiful community! In the ever-evolving landscape of investments, I'm curious to hear about the strategies that savvy investors are currently employing. I am navigating the financing of a deal via a DSCR loan and have encountered an intriguing decision point.

The options I am presented with are as follows:

1. 1. Opt for an interest rate of 9.125%, which would result in decreased cash flow and a larger payment amount, with a lesser contribution towards principal. However, this option provides the advantage of only a 1% prepayment penalty for the first five years.
2. 2. Choose an interest rate of 8.5% (no point buydown) but accompanied by a steeper 5% prepayment penalty, which reduces by 1% annually. The core distinction between these two options, other than the interest rate, lies in the varying prepayment penalty scales: 4% more for the first year, 3% for the second, and so on.

With the latter option, my cash flow is healthier in the present context. Although one might think of refinancing as a viable approach when rates drop, predicting such shifts in the financial terrain is, unfortunately, beyond our skills—it could be a year or even a decade away.

I would love to gain insights into how many of you are structuring your financing in today's market. I am inclined towards the option offering a lower rate, as it provides a superior cash flow in the present and future, I will make more money starting today and my tenants will pay off more principal sooner. Nonetheless, should I choose to refinance within the next five years, penalties will invariably factor in, and thus any refinancing would necessitate a significantly more favorable rate to make it worthwhile.

Your valuable perspective is greatly appreciated. Thank you in advance for your insights!