Definition
Interest reserve is a construction loan fund set aside to pay interest during building, reducing out-of-pocket payments. Unused reserves from early completion are refunded.
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Construction loan interest accrues during building; interest reserves fund these payments without requiring borrower cash. Interest reserve is typically calculated on loan balance over expected construction timeline. Unused interest reserve (from early completion) is refunded. Interest reserve adds to total loan amount. Using interest reserves is common practice for owner-built and semi-custom homes.
Pro Tip
Verify interest reserve covers full construction timeline with contingency. Shortfalls create unexpected interest payments.
Example
A $300,000 construction loan with 8% interest and 12-month timeline includes $12,000 interest reserve covering estimated interest payments.