Why would a borrower need an interest reserve?

For a traditional real estate lender it is always all about Debt Service Coverage (DSC).  If you are looking for a bank loan on an income property the first question the bank will ask you is “what is the DSC ratio?”  If your loan payment on the requested bank loan will be $1,000 per month then the bank will require that the rental income on the property after paying all operating expenses must be at least $1,200 per month.  If it isn’t, you can kiss your bank loan goodbye.

Frequently the best investment opportunities are found in partially leased properties or even empty properties. Obviously, these properties do not have the DSC that banks require.  A savvy investor will realize that working with a Colorado hard money lender like Montegra who can offer an interest reserve to overcome DSC requirements offers opportunities not found with traditional lenders.

What is an interest reserve and how does it work?

Let’s assume that you purchase a property that is only 50% leased and thus doesn’t have sufficient DSC to get a bank loan. You contact a reputable local bridge lender and they offer you a loan of $1,000,000 towards your purchase.  However, in order to allow you the funds to make the monthly loan payments the lender puts $100,000 of loan principle into an escrow account, which is designated an “interest reserve escrow account”.  Each month for 10 months the bridge lender pays out $10,000 from the interest reserve account to make the required loan payments.  Meanwhile the owner is actively looking for tenants to lease up the vacant space.  At the end of the 10 months the property is now 90% leased and the income is sufficient to make the loan payments without needing to draw on the interest reserve.

How does this help the borrower?

Because the purchaser/borrower bought a 50% vacant property he paid considerably less than if it had been fully leased.  Now that the property is up to what lenders call a “stabilized” income the property is not only worth considerably more to a new buyer but it now qualifies for a conventional bank loan.  The property owner goes down to their bank and refinances out the hard money loan at the record low bank rates now offered for properties that are “stabilized”.  Without working with a a flexible hard money lender who could set up an interest reserve, the owner would not have been able to acquire the property in the first place and would have lost the opportunity to create a large amount of equity.

Can an interest reserve be used to buy an empty building? 

Yes.  Montegra recently helped one of its Borrower’s close the purchase on a prime retail building that had been owned by a furniture store for years but was closed when the owners decided to retire and also sell the building.

This blog was written by Bob Amter, President of Montegra Capital Resources, LTD., a Colorado hard money lender.  [google_authorship] has been in the private capital lending business for 41 consecutive years.