Reserves, Prepaid Interest, Prepayment Penalty,
& Interest Holdbacks in Trust Deed Investing

In this issue, I would like to breakdown four commonly used – and often misunderstood – terms in private lending:  Interest Reserves, Prepaid Interest, Prepayment Penalties, and Holdbacks.

Whether you’re a seasoned investor or new to trust deeds, these definitions help clarify how your investment is structured and protected:

💰Interest Reserves

What is it:
A portion of the loan proceeds set aside at closing to pay your monthly interest returns, typically for a set period of time (e.g., 6–12 months).

Why it matters:
Interest reserves ensure that you receive timely interest payments regardless of the borrower’s cash flow – especially helpful for loans on properties that aren’t income-producing yet. This also helps to ensure that a borrower has a good payment record and increases their ability to refinance within the term of the loan.

🧾 Prepaid Interest

What is it:
An upfront interest payment collected from the borrower at closing, usually covering a set number of months (e.g., 3–6 months). During this period, the borrower is not required to make monthly mortgage payments, and their regular payments begin once the prepaid interest period ends.

Why it matters:
Prepaid interest provides immediate return to the lender and gives the borrower a payment cushion during the early phase of the loan—especially helpful for transitional or renovation projects.  This structure can benefit both parties—lenders earn interest upfront, and borrowers have time to get their project off the ground before monthly payments begin.

🔁 Prepayment Penalty

What is it:
A fee the borrower may be required to pay if they repay the loan before a certain period (e.g., within the first 6 or 12 months).

Why it matters:
This protects your anticipated return. Without a prepayment penalty, a borrower could refinance quickly, cutting your expected interest income short. It also helps ensure that your capital stays placed long enough to meet your goals.

🛑 Holdbacks

What is it:
Funds withheld at closing and released to the borrower only when certain milestones are met—such as completing construction milestones or clearing a lien.

Why it matters:
Holdbacks add an extra layer of protection for your investment. They ensure funds are released in phases, reducing risk and encouraging borrower accountability.

In Summary:

• Interest Reserves = Reserved funds for your monthly interest payments.
• Prepaid Interest = Borrower-paid interest collected upfront at closing.
• Prepayment Penalty = Ensures your return isn’t cut short by an early payoff.
• Holdbacks = Funds withheld until specific borrower obligations are met.

Myself and my team are always here to help you understand your investment from every angle.  Any questions or requests, don’t hesitate to email me or call the office at 707-708-0797.

Thank you for being a valued partner in private lending!