Short answer
An interest reserve sets aside part of the mortgage advance to make scheduled interest payments for an agreed period. It can provide temporary cash-flow room, but it is not free money. The reserve reduces the net funds available to the borrower and may increase the amount secured against the property. Confirm the gross loan, reserve amount, monthly payment, net proceeds and maturity balance. Use it only when the financing purpose and exit remain workable after the deduction.
The client’s concern
You need the mortgage, but the monthly interest payment would strain cash flow while a property is sold, construction finishes or income recovers. A lender may offer prepaid interest or an interest reserve.
How the reserve works
Assume a $200,000 private mortgage at 10% with six months of interest reserved. A simple illustration is $200,000 × 10% ÷ 12 × 6 = $10,000. If that amount is deducted from the advance, the borrower receives $190,000 before lender, brokerage, appraisal and legal costs. The registered debt may still be $200,000.
The commitment controls the real calculation. Some structures deduct the reserve from the advance; others capitalize amounts differently. Ask who holds the reserve, how payments are applied and what happens to unused funds after an early payout.
When it may fit
- A documented sale is expected within the term.
- Renovation or construction has a supportable completion and takeout plan.
- Temporary income disruption has a known recovery date.
- Monthly payment relief prevents an immediate cash-flow failure while the exit is completed.
When it hides the problem
A reserve is weak when the borrower cannot afford the mortgage after it runs out, the exit depends on appreciation, or the net funds no longer solve the original need. Prepaying interest can delay the symptom without repairing the file.
Questions to ask
- How much is reserved?
- Is it deducted from the advance?
- What net cash reaches the lawyer?
- Does interest accrue on the reserved amount?
- What happens if the loan pays out early?
- What is the plan when the reserve ends?
Request a mortgage second opinion through SimplifyMortgage.ca to compare the reserve with a monthly-payment structure and confirm which leaves the client in the stronger position.