Capitalized Interest Reserves & Dutch Interest in Commercial Debt
During commercial construction, gut renovation, or major lease repositioning, a property generates little or no operating cash flow to service mortgage payments. Lenders solve this cash flow gap by structuring a Capitalized Interest Reserve directly into the loan commitment. Understanding how interest reserves are sized and whether the lender charges "Dutch interest" is critical to modeling project carry costs.
Indicative Underwriting Matrix
Dutch interest structures dramatically increase effective borrowing costs. Verify whether debt term sheets calculate interest as-drawn or on total commitment.
How Lenders Size Capitalized Interest Reserves
In a transitional bridge or construction loan, the lender establishes an interest reserve account. Each month, rather than requiring the borrower to write an out-of-pocket check for monthly interest, the loan servicer automatically draws the required interest payment directly from the reserve account and credits the loan.
To size the reserve, the underwriter models the draw schedule, factoring in the construction timeline, stabilization lag, projected floating interest rate increases, and a 2 to 3-month safety buffer. Sizing the reserve correctly ensures the project does not experience a technical interest default during construction.
The High Cost of Dutch Interest in Bridge Lending
A crucial distinction in private debt fund and bridge lending is whether the facility features "Dutch interest."
Under standard bank financing, you pay interest only on funds actually drawn and disbursed (As-Drawn). Under a Dutch interest structure, the lender charges full contractual interest on the entire approved loan commitment from Day 1—even if $3,000,000 of renovation capex remains undisbursed in escrow for 18 months. On a $10,000,000 facility with an 8.5% rate, paying Dutch interest on a $3,000,000 undisbursed line adds $255,000 in unnecessary annual interest expense.
Frequently Answered Financing Questions
Verified answers to common borrower and broker inquiries regarding loan sizing, guidelines, and execution.
What is Dutch interest in commercial real estate lending?
Dutch interest is a lending structure where the borrower pays interest on the entire committed loan amount from Day 1, including future funding holdbacks that have not yet been drawn.
Borrowers should negotiate for as-drawn interest structures with a modest 0.25%–0.50% unused commitment fee to avoid paying full interest on unadvanced funds.
Submit Financing Scenario →What happens if a commercial interest reserve runs out before the property is stabilized?
If the interest reserve exhausts before stabilization, the borrower must immediately begin paying monthly debt service out-of-pocket from sponsor liquidity or face loan default.
Borrowers should model conservative construction and leasing timelines, ensuring the interest reserve carries at least a 3 to 6-month buffer beyond projected stabilization.
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