Interest reserves for private real-estate loans: funding, depletion, and borrower shortfall

Five reserve numbers that should never be confused

An interest reserve is money set aside at closing to cover a borrower's early interest payments. It sounds simple until month three, when five different figures all get called "the reserve." Keeping them separate is most of the work.

• Funded balance — what remains in the reserve today.
• Planned draw — what the schedule says should come out this period.
• Actual movement — what actually came out, including manual adjustments.
• Projected depletion — the month the reserve is forecast to run dry.
• Borrower shortfall — the interest the borrower must pay once the reserve can't cover it.

Confuse the funded balance with the amount due and you will tell a borrower they owe nothing while their reserve quietly runs out. Confuse planned with actual movement and your projection drifts from reality within two periods.

Fixed, interest-matched, and manual draw behavior

A fixed draw releases the same amount each period — simple, but it diverges from the real interest bill as the balance changes. An interest-matched draw releases exactly the period's accrued interest, so the reserve tracks the actual charge. A manual draw is whatever you post by hand for a workout or correction. The behavior you choose changes the depletion date and the borrower's first out-of-pocket month, so record it on the loan rather than re-deriving it each month.

A month-by-month depletion example

Take a $500,000 loan at 12% (Actual/365) with a $30,000 interest-matched reserve. Each month releases roughly that month's interest:

In month six the reserve covers all but $82.20, and that shortfall becomes the borrower's first out-of-pocket interest. From month seven the borrower pays the full amount.

Start$30,000.00

Month 1$24,904.11

Month 2$19,972.60

Month 3$14,876.71

Month 4$9,945.20

Month 5$4,849.31

Month 6$0.00

Month 6 covers all but $82.20 — the borrower's first out-of-pocket interest.

What happens when coverage runs out

When the funded balance can no longer cover a period, the shortfall must appear on the invoice as interest due. A reserve that silently goes negative is a servicing error, not a feature — the money did not come from anywhere. Surface the crossover month ahead of time so the borrower is not surprised by their first real payment.

Top-ups, releases, and settlements

Reserves get topped up at an extension, partially released at a paydown, and trued-up at payoff. Each is a dated reserve transaction — not an edit to the original funded amount — so the reserve's history stays intact and auditable. At payoff, any remaining funded balance is credited against the payoff amount, which is why a payoff letter can show a reserve credit that reduces the total due.

Why capitalized interest is a different event

Capitalizing unpaid interest into principal is a modification, not a reserve draw. It increases the balance the loan accrues on going forward, so it must be posted as its own dated event with a before/after preview. Treating a capitalization as a reserve movement understates principal and every future interest figure that depends on it.

Reconciling the reserve

At each close, the reserve should reconcile: opening funded balance − actual draws + top-ups − releases = closing funded balance, and the sum of draws should equal the interest they covered. A reserve that will not reconcile is usually a manual draw posted without a matching interest charge, or a top-up recorded as income.

Where LoanConsole fits

LoanConsole keeps the funded balance, reserve transactions, selected draw behavior, projected depletion, and borrower shortfall attached to the loan. It records reserve activity and calculates on it; it does not custody the funds or perform a RESPA escrow analysis.