| For | Builders and developers planning business-purpose projects |
| Main distinction | Interest reserve pays financing costs; contingency addresses unexpected project costs |
| Example | Hypothetical budget, not a loan offer or completed deal |
| Next step | Review the budget, draw schedule and repayment plan together |
An interest reserve and a construction contingency serve different purposes. An interest reserve sets aside money for loan interest during a defined period. A contingency provides a budget allowance for unforeseen project costs. Neither automatically supplies the working cash needed to pay contractors before a lender releases a draw. A builder financing request should show all three separately.
This distinction matters when comparing construction term sheets. Two lenders may describe the same headline loan-to-cost percentage while treating interest, contingencies, deposits and other costs differently. The useful question is how much money reaches each purpose, when it becomes available and who funds any shortfall.
Separate the three cash needs before requesting terms
- Interest reserve: a designated amount for interest payments. It may be loan-funded or borrower-funded, depending on the agreement.
- Construction contingency: an allowance for eligible, unexpected costs such as concealed conditions or changes required during the project.
- Working cash: accessible funds for deposits, work awaiting reimbursement and other payments that cannot wait for the next approved draw.
The OCC describes interest reserves as part of construction and lease-up financing and emphasizes the timing of disbursements, completion and repayment. That banking guidance is useful background, but it does not establish a reserve requirement or program promise for every lender. See the OCC Commercial Real Estate Lending handbook.
A hypothetical construction budget with distinct reserves
Consider a business-purpose project with the following illustrative cost plan. These are planning numbers selected to show the arithmetic, not Stonehaven loan terms. The contingency is a chosen assumption, not a statement that this percentage is sufficient for every build.
| Budget item | Amount |
|---|---|
| Land acquisition | $600,000 |
| Hard construction costs | $1,500,000 |
| Professional fees, permits and other soft costs | $180,000 |
| Construction contingency | $150,000 |
| Interest reserve | $120,000 |
| Total modeled uses | $2,550,000 |
If a hypothetical loan commitment is $2,040,000, it equals 80% of this modeled cost. The remaining funding requirement is $510,000. That calculation alone does not tell the borrower how much must be wired at closing or retained afterward. Existing land equity, lender cost eligibility, closing disbursements and reserve funding all need their own reconciliation. An unfunded loan commitment is not cash in the operating account.
Avoid adding the same reserve twice. If the $120,000 interest reserve is already included in both the budget and committed financing, it is not an additional free allowance. If the lender excludes a cost category, rebuild the sources-and-uses statement so the borrower contribution remains visible. Our guide to 100% eligible LTC and builder cash needs explains why a leverage headline does not settle this question.
Stress-test the schedule, not just the construction price
Suppose the original $120,000 reserve plan represents 12 months of an assumed average $10,000 monthly interest cost. Three additional months at the same assumed monthly cost require another $30,000. This is a cash-planning illustration, not a quoted interest rate or a loan-payment calculation. Actual interest depends on the note, outstanding advances, timing and any interest charged on previously financed costs.
A separate $45,000 construction change order would reduce the $150,000 contingency to $105,000 if the lender approves that use. Paying the additional $30,000 of interest from the same contingency would reduce the remaining protection again and may not be permitted. Put each request through the lender's approval process rather than assuming budget categories can be moved freely.
Build three versions of the timeline: the expected completion and exit, a modest delay, and a longer delay that reaches loan maturity. Include inspection availability, utility connections, final approvals and the time to sell or refinance. A finished building and a repaid construction loan are different milestones.
Ask these questions when comparing financing
- Is the interest reserve within the stated loan commitment, separately funded, or absent?
- Is interest charged only on drawn balances or on another contractual basis?
- What reserve assumptions were used for draw timing and repayment?
- Who approves contingency use, and what documentation is required?
- Must borrower equity be used before advances begin?
- What happens if the reserve runs low before the project is complete?
- What extension conditions, fees and additional cash requirements apply?
A larger reserve does not repair an unrealistic exit. The OCC's refinance-risk guidance emphasizes reviewing repayment capacity under changed conditions. For your own model, reduce the expected sale proceeds or refinance amount and see whether the remaining debt and costs can still be paid.
What Stonehaven can help prepare
Stonehaven is a mortgage brokerage that arranges financing through third-party lenders. We can review the proposed budget and capital request, identify questions for lender placement and compare how potential structures handle reserves and draws. Send the project location, ownership or purchase position, itemized budget, requested financing, experience and expected exit. Start with our construction financing page; we follow up by text. Availability and final terms depend on the lender and project.
Frequently asked questions
Does an interest reserve mean I never make a payment? No. It is a limited funding source governed by the loan agreement. A shortfall or ineligible expense may still require borrower cash.
Is contingency money paid to me at closing? Not necessarily. A budget allowance may remain controlled and only become available after an approved request. Confirm the actual disbursement rules.
Can owned land replace all cash reserves? Land equity may help the overall financing structure, but it cannot pay a contractor invoice unless cash is available through an approved advance or another documented source. Review both equity and liquidity.
Can the lender increase the reserve later? An increase is a new credit decision or contractual accommodation, not an automatic entitlement. Plan the cash response before relying on an extension or additional loan proceeds.