Construction commitment, funded balance and interest

Multiplying a construction commitment by the note rate and the project duration often gives the wrong interest budget. It assumes the full commitment is outstanding for the entire period. The opposite shortcut—using half the commitment for every project—can also fail when land, financed fees or early construction draws create a large initial balance.

Build interest from the advance schedule and the loan’s actual accrual convention. Then identify who pays the interest. Sponsor-paid interest consumes equity; financed interest increases debt and can itself create later interest. Neither treatment creates free money.

Start with the loan balance, not total project cost

The hypothetical project below has a $2.7 million loan commitment. At closing, $600,000 is advanced toward a $1 million land purchase and a $30,000 fee is financed. The initial principal is $630,000, even though only $600,000 reaches the land transaction. The sponsor supplies the other $400,000 for the land.

Six monthly construction draws of $300,000 follow, totaling $1.8 million. The model assumes the lender funds those approved construction costs, the sponsor pays interest from separate cash, and no principal is amortized during the six months. This is a chosen funding order, not a claim that every construction loan works this way.

The OCC’s interest-reserve discussion emphasizes draw timing, rates and time to completion when evaluating reserves. The following schedule is an original simplified calculation using those kinds of inputs, not a lender-approved budget.

Use a clearly stated timing convention

Assume 12% annual interest and use one-twelfth of that rate for each modeled month. Each construction draw is treated as occurring evenly through the month, so interest uses the average of beginning and ending principal. Actual daily draws, day-count conventions and billing periods can produce different amounts.

The ending balance is $600,000 land funding + $30,000 financed fee + $1.8 million construction draws = $2.43 million. The $91,800 of sponsor-paid interest does not increase that principal. Remaining commitment is $270,000, but further availability still depends on the approved budget and loan conditions.

Reconcile the entire project once

Add $78,200 of other project costs, assumed paid by the sponsor. Total uses are $1 million land, $1.8 million construction, $30,000 financed fee, $91,800 interest and $78,200 other costs: exactly $3 million.

Sources are $2.43 million funded debt and $570,000 sponsor cash. The sponsor contribution consists of $400,000 land equity, $91,800 interest and $78,200 other costs. The $30,000 fee is a use funded by debt; it is not deducted again from sponsor cash after the gross sources-and-uses table already includes it.

The unused $270,000 commitment is not another source for already completed uses. Present it separately as possible future availability, with its conditions. Counting the whole $2.7 million commitment as funded debt would understate contributed equity by $270,000.

Test the delay at the balance where it happens

Suppose completion is delayed two months after month six, with no additional project draws. At a constant $2.43 million balance and the same simplified 12% rate, each month adds $24,300 of interest. Two months require $48,600 more cash, before insurance, taxes, security, overhead or other delay costs.

That delay is more expensive than two early months on a $630,000 balance. A contingency described only as “two extra months” is incomplete without specifying the expected principal at that point.

If the lender agrees to finance the additional interest, revise both the draw schedule and the expected payoff. Do not retain the $2.43 million payoff while also removing the sponsor’s interest contribution. Whether additional borrowing is available requires a contractual and underwriting answer, not an unused-commitment subtraction alone.

If interest is financed, rebuild the recurrence

For a financed-interest structure, begin with outstanding principal, add the period’s project advances, calculate interest under the contract, and add any funded interest at the specified date. The next period begins with the resulting balance. If the fee or interest is withheld from an advance, distinguish the gross principal increase from the net cash reaching the project.

Interest on financed interest can create circularity if a spreadsheet tries to calculate the entire reserve from a final loan amount that already includes that reserve. A period-by-period recurrence is easier to inspect. Where the agreement uses daily accrual or draws occur on irregular dates, use the actual dated schedule.

The lender discussion to have before construction starts

Confirm the equity-funding order, fee treatment, draw submission and inspection process, retained amounts, interest calculation and conditions for reallocating budget lines. Ask how cost overruns and depleted reserves are addressed and what evidence is required for future advances.

Keep the contractor payment schedule alongside the lender advance schedule. Reimbursement delays create temporary working-capital needs even when total debt and equity cover the final budget. A useful construction model shows the peak cash requirement, the maximum expected debt balance and the amount that must be refinanced or repaid at the end.