In one sentence
Loan proceeds set aside to pay interest during a period when a property does not yet generate enough cash flow, common in construction and bridge loans.
The longer version
When a property is under construction or leasing up, it cannot cover debt service, so the loan funds its own interest from a reserve sized in underwriting. When the reserve runs dry before stabilization, trouble follows.
Interest reserve burn is a monitored servicing metric on transitional loans, because it is an early signal of a business plan running behind.
Common questions
- What is an interest reserve?
- Loan proceeds set aside to pay interest while a property does not yet produce enough income, common in construction and bridge loans.
- How is an interest reserve sized?
- By projecting interest over the expected construction or lease-up period at the loan rate, usually with a cushion for delays or rate increases on floating-rate loans.
- What happens when the interest reserve runs out?
- The borrower must pay interest from its own funds. Running out early is a sign the business plan is behind, and some loans require the borrower to rebalance the reserve.
Keep reading
- The construction loan closing checklistThe initial close, then the monthly draws.
- How life companies run commercial mortgage operationsThe long servicing tail.
- The due diligence checklist, built to be runChecklists as systems, not documents.
- Loan administrationWhere this is tracked after funding.
- Construction loan calculatorEstimate the reserve from the draw schedule.