An interest reserve is a portion of a real estate loan — set aside at closing — that is specifically designated to cover interest payments during the loan term. It is most commonly used in construction loans where the property is not yet producing income sufficient to cover debt service. Rather than requiring borrowers to pay interest out of pocket each month, the lender holds the reserve and automatically deducts interest from it as it accrues.
During the construction or stabilization phase of a real estate project, the property generates no income — or insufficient income — to cover interest payments. Requiring cash interest payments during this period would strain borrower liquidity and create default risk. By building an interest reserve into the loan budget, the lender funds the interest payments itself (from the reserved amount) while the project is being built or stabilized. This is a win-win: it reduces borrower cash flow pressure while giving the lender confidence the loan will stay current during the transition period.
The interest reserve is calculated by projecting the total interest that will accrue over the construction or stabilization period. Since the loan balance grows as draws are funded, interest accrues on an increasing balance over time. The formula estimates: average outstanding balance × annual rate × projected term in months ÷ 12. Example: A $2,000,000 construction loan with a 12-month term at 11% interest with draws spread evenly over 10 months might require an interest reserve of approximately $110,000–$130,000.
Loans on properties that are vacant or undergoing renovation may include an interest reserve. The reserve helps carry interest during the transition period while the sponsor completes the work and prepares for a sale or DSCR refinance.
Related Loan Program
Learn more about how Riverside Park Capital structures this loan type, rates, terms, and eligibility.
View Program