An account set up by the lender that pays the loan's interest during construction and lease-up, usually funded as a line in the loan budget.
The OCC handbook defines an interest reserve as a reserve account established by the lender and used by the borrower to cover loan interest during construction and lease-up. It is typically a line item in the loan budget, so the bank advances the interest and adds it to the balance. It can also be an escrow the borrower funds with cash.
The reserve should be sized to carry interest through completion and then through lease-up, sale or occupancy. During lease-up, the property’s cash flow should pay interest first, with the reserve covering the gap. Once cash flow covers interest, draws on the reserve stop.
The handbook says a reserve is not a fit for a stabilized property or for raw land held on speculation. If delays use the reserve up early, the bank generally requires the borrower or guarantor to put in more cash. Examiners look hard at any decision to refill a reserve with more debt instead.
How it shows up in the data here
No public file shows whether a loan has an interest reserve or how much is left in it. Bank call reports show the construction and land balance held, and interest drawn from a reserve is part of that balance. Lenders with construction on their books are listed at construction lenders and ranked by size at construction books. Reserve terms are set loan by loan and are not in the data.
Go further
- Construction lenders by state: Lenders with construction balances, state by state.
- Maximum loan calculator: The loan each test allows: DSCR, LTV and debt yield side by side, and which one binds.
- Construction loan package checklist: A construction lender is lending against a building that does not exist yet. The package has to show what it will cost, who will build it, where every dollar comes from, and how the loan gets repaid when it is done.
- How bankers evaluate a commercial loan deal: A credit officer asks one question five ways: how will this loan be repaid, and what happens if it is not? Knowing the five tests lets you size a request before you send it.
Related terms
- Construction loan: A short-term loan that pays for building or renovating a property, advanced in stages as work is finished and repaid from a sale or a permanent loan.
- Construction draw: One advance of construction loan money, released after the lender confirms that the work it pays for is in place.
- Cost overrun: The amount by which a construction project costs more than its budget, which the borrower is normally expected to cover.
- Lease-up: The period after a building is finished or renovated while it fills with tenants and its income climbs toward a stable level.
- Guarantor: A person or company that promises to repay a loan if the borrower does not. On a loan to an LLC or corporation, the guarantor is usually an owner.
Sources
Plain definitions for orientation, not legal, tax or credit advice. A lender's own policy decides what it will do.