Interest Reserve
An interest reserve is a portion of a loan's proceeds that the lender sets aside at closing to cover the borrower's interest payments during a construction or transition period, before the asset produces income. It draws down as interest accrues, and a reserve that runs dry before the project stabilizes is a common source of trouble in construction and bridge lending.
How an Interest Reserve Works
When a loan funds an asset that does not yet generate cash, such as a property under construction or a value-add deal mid-renovation, the borrower has no income to make interest payments from. Rather than require the borrower to pay out of pocket, the lender funds an interest reserve, a pool carved from the loan proceeds, and draws against it each period to pay the interest due. The reserve declines as interest accrues and, on a floating-rate loan, as the rate moves.
Where Interest Reserves Are Used
Interest reserves are most common in construction loans, bridge and transitional real estate loans, and value-add deals, where there is a defined period between funding and the point the asset can service its own debt. The reserve is sized to cover projected interest through that period, often with a cushion.
Why Lenders Monitor Reserve Burn
The central risk is that the reserve depletes before the asset stabilizes. Delays extend the period the reserve must cover, and on floating-rate debt a rate increase burns it faster than projected. A reserve running low while the project is incomplete forces a hard choice: replenish, restructure, or default. Lenders track reserve balance against the remaining timeline so a shortfall surfaces while there is still room to act.
Servicing the Reserve
Tracking interest-reserve burn alongside draws, the funded balance, and covenants is core to servicing a construction or bridge book. Zolvo monitors reserve burn, draws, maturities, and covenants in real time through portfolio monitoring, see how it applies to bridge lending and commercial real estate.
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