The cost of a step-down prepayment penalty is calculated based on the remaining balance at prepayment in conjunction with the amount of time that has passed since the closing of the loan or the most recent rate reset. Generally, the penalty is a straightforward declining payment schedule. For example, a 5-4-3-2-1 schedule for a 5 year loan term would make the borrower responsible for paying a penalty of 5% of the outstanding balance if prepaying the loan in the first year, 4% in the second year, 3% in the third year, and so on. Another common step-down structure for a five-year loan term is the 3-1-1, which only penalizes the borrower if the debt is prepaid within the first three years of the term. Many lenders do not impose a step-down penalty in the last 90 days of a loan term. Learn more about Step-Down Prepayment Penalty.