Interest reserves are one of the most important but least understood components of construction financing. They protect developers from default when projects experience delays — and delays are almost inevitable in commercial construction.
In this article, Sarah Collins, Senior CRE Underwriter at Fintek Capital LLC, explains how interest reserves work, why they matter, and how to structure them properly.
What Are Interest Reserves?
An interest reserve is a pool of capital set aside at loan closing to cover interest payments during the construction period. Instead of the developer making monthly interest payments out of pocket, the lender draws from the reserve each month.
Why Interest Reserves Matter
Construction projects rarely finish on time. Weather delays, permitting issues, material shortages, and contractor scheduling conflicts can push timelines out by 3-12 months. Without an interest reserve, the developer must fund these additional interest payments from personal capital — which may not be available.
How to Calculate Interest Reserves
A proper interest reserve calculation considers: expected construction timeline plus realistic overrun, blended interest rate (rate increases as draws increase), monthly interest payments at each stage, and a buffer for unexpected delays.
Common Mistakes
- Underestimating the timeline: Budgeting for 12 months when the project will take 16.
- Not accounting for rate increases: As construction draws increase, so do monthly interest payments.
- Insufficient buffer: A 3-month reserve for a project that routinely experiences 6-month delays.
- Using reserves for other costs: Interest reserves should only fund interest payments.
Conclusion
Interest reserves are not optional — they are essential. Contact Fintek Capital LLC to structure construction financing with properly sized interest reserves.