Interest Due Over the Life of a Construction Loan
Apr 15, 2021We'd love to address a question we get very often about interest reserve accounts and the interest that is due over the life of a construction loan.
A lot of people ask,
- I'm about to close on my construction loan for my FIG fourplex purchase. What's next?
- Am I going to be making payments every month? What does that look like?
- What interest is due?
With FIG's model, when you close on your construction loan, you are responsible for the interest that accumulates over the life of your construction loan. With how large some of these developments are in scale, our construction partners want to avoid a situation where every single investor is having to cut a check to the bank each month for the interest that accrues.
So right when you close on your construction loan, the balance on your construction loan is going to be really small, because nothing's been done yet. Your property hasn't been built. Early on in the process, the builder will get started on some of the foundation work, maybe some initial plumbing, and prep for framing. Your balance is going to be very low at that point.
Over the life of your loan, as the builder makes progress on your property, they will make draws each month from the bank to request money to build out certain phases of your property. During the 12 month period, the loan amount will gradually increase all the way to your note amount, which is the amount that was going to be borrowed in total, by the end of construction.
That balance is going to get a little bit bigger every month. Our construction partners (the bank) essentially have a formula that says, "on a loan amount of your size, we anticipate that X amount of interest will accumulate over the life of the construction loan (about 12 months)."
Instead of having you write a check each month for the balance of interest that accumulated that month, they come up with a figure upfront. That number is based on the formulas that they have and use for construction loans all of the time. They're very familiar with this.
This interest money is collected at the time of your construction closing (prior to breaking ground) and is put into what's called an interest reserve account, or interest savings account.
Funds set aside for prepaid interest will sit in your interest reserve account and every month as interest accrues on your property, you'll receive a statement specifying how much needs to be withdrawn for construction partners. Since all of these funds will come out of the reserve account, you don't have to make any payments during the build period because you've already prepaid it.
- What if there are funds left over in my interest reserve account after construction is complete?
If your property is built and there are funds left over that have been unused, and we complete your refinance, the bank cannot keep the excess funds. The money is either refunded back to you in the form of a credit on your pay off, or it will come back in cash. Legally they are not allowed to pocket the leftover funds. This is what makes it a great model.
Investors love how FIG has structured these interest savings accounts because, by default, most people don't want to make these payments each month and are okay prepaying it.
When you look at any of the Fourplex Investment Group's proformas and see the closing cost breakdown, you'll see a line that says "interest reserve". Now you know what that fee is used for, how it breaks down, and how it is relevant to your transaction.
If you have any questions on this, we're happy to go through it over email/phone. You can schedule a chat with any member of the FIG team and they'll get you comfortable with the process and numbers.
