Interest Reserve
Interest reserves are a common devise within real estate debt financing instruments, and are most often used in debt structures. Borrowers fund interest reserves as capital that the lender holds in a collateral account, providing another layer of security for lenders.
These reserve accounts may be funded in several different ways, but are typically funded in one of the two following ways:
- “Pre-funded” or Upfront: the lender initially closes and funds the loan, a portion is held back in the reserve.
- Ongoing: payments are made into the reserve account by the borrower at regular intervals – typically monthly – out of the cash flows from the property. In some cases, the lender will collect rent payments for the property directly into the reserve, distributing the balance above the contractually established amount back to the borrower.
Funds in an interest reserve account may be maintained as a buffer to pad the DSCR of a given loan, to fund interest payments (in part or in whole), or some combination thereof.
Example of a debt real estate investment on EquityMultiple with returns coming in part from a pre-funded interest reserve
EquityMultiple may employ interest reserves in the structuring of preferred equity investments, establishing pre-funded or partially pre-funded interest reserves to pre-establish funding of current preferred returns.