Nine months of interest, paid at the closing table. Not by the borrower. By the loan. That is what an interest reserve does, and for the right project it is the difference between a loan that competes with your rehab for cash and a loan that carries itself.
What an Interest Reserve Is
When a loan is sized with an interest reserve, the interest for the full term is calculated up front, carved out of the loan proceeds at closing, and held. Each month, the payment is drawn from that reserve instead of from your bank account. The loan pays its own interest until the reserve is used up or the loan is paid off.
On a nine-month loan with a $2,545.83 monthly payment, that is $22,912.50 set aside on day one. You never write a check. You never set up an autopay. The servicer moves the payment from the reserve to the interest ledger on the first of each month, and you get a statement showing it happened.
What It Actually Costs
It is not free money, and we would rather say that plainly than let you find it on the settlement statement. You are borrowing the carry. The reserve is part of the loan amount, which means two things.
First, the loan is bigger than the cash you take away. On the example above, a $235,000 loan put $201,692.50 on the closing table after points, the document fee, and the reserve came out. Second, because our loans carry Dutch interest, interest accrues on the full loan balance, including the portion sitting in the reserve. The reserve itself is earning interest for the lender while it sits. That is the price of not having the payment touch your operating account.
The bigger loan also has to fit under our 70% cap, same as any other dollar we lend. If the property supports $200,000 at 70% and the reserve pushes the ask to $215,000, we size the reserve down or tell you the structure does not work. You hear that on the term sheet, not at closing.
When We Build One In
We do not put a reserve on every loan. Most of our borrowers carry their own payments and prefer the smaller loan balance. We build a reserve in when the monthly payment would compete with the project for the same dollars. Three situations come up most often.
No income outside the project. If the only cash coming in during the term is the cash the project eventually produces, a monthly payment is a liability with no matching income. The reserve fixes that mismatch.
A cash-heavy first sixty days. Demo, rough-in, and materials front-load the spend on most rehabs. A payment landing in the same window as the framing invoice is how good operators end up late on a loan they could easily afford by month four.
The deal that funds a second deal. When a cash-out on one property is paying for the purchase of another, the borrower's cash is spoken for. That was the Richmond operator in this week's case study: the reserve let him put his own money into the second property instead of into carrying the first.
What Happens at Payoff
This is where reserve structures differ between lenders, and where you should read the note carefully. Some lenders pair a reserve with a minimum-interest clause, so paying off in month three still costs you all nine months. The reserve becomes a prepayment penalty with a friendlier name.
Ours does not work that way. Pay the loan off early and the unused months in the reserve come back to you on the payoff statement. There is no prepayment penalty and no minimum interest. If you borrowed nine months of carry and only needed four, you pay four.
What It Does Not Do
A reserve covers interest. It does not cover taxes, insurance, utilities, or the rehab itself. It does not extend the term; when the nine months are up, the balance is due, reserve or not. And it does not make a thin deal work. If the numbers only pencil because the payment disappeared for nine months, the payment was not the problem.
How to Ask for One
Tell us what your cash is doing during the term. If the answer is "sitting in the rehab" or "buying the next one," say so, and we will price the loan both ways: with the reserve and without it. You see the loan amount, the cash to close, and the payoff math side by side on one term sheet and pick the version that fits.
So a slow month on your other projects cannot make this loan late. So you are never choosing between paying the contractor and paying the lender. So the loan that funded the deal also funds the time it takes to finish it. Call us at 804-208-0465 or use the Discuss My Deal form.