Full commitment vs. drawn balance interest

The two methods

With full commitment interest — sometimes called Dutch interest — the borrower pays interest on the entire loan amount from closing, including the construction holdback that hasn't been drawn yet. With drawn balance interest — sometimes called non-Dutch — the borrower pays interest only on the amount actually disbursed, so interest grows as draws are funded.

Neither is inherently better. They're different trade-offs between yield, borrower cost, and competitiveness.

A worked example

Take a $400,000 loan: $300,000 funded at closing for the purchase and a $100,000 rehab holdback, 12% interest, 365-day year, six-month term. Assume the holdback is drawn evenly — about $33,333 at the end of each of the first three months.

On full commitment, the borrower pays interest on $400,000 for the full term: about $131.51 per day, or roughly $23,800 over six months. On drawn balance, interest starts on $300,000 (about $98.63 per day) and rises with each draw, totaling roughly $21,800 — about $2,000 less.

Why lenders choose full commitment

Full commitment interest is simpler to calculate and produces a higher yield. It also compensates the lender for keeping capital available for the holdback. If your capital is sitting ready for draws, you're paying for it whether or not the borrower has drawn yet.

Why lenders choose drawn balance

Drawn balance interest is more borrower-friendly and can make your terms more competitive, especially on loans with large rehab budgets. It also matches your earnings to the capital you've actually deployed, which can be appealing if your capital isn't reserved for the holdback until draws are funded.

Questions to ask when deciding

Many lenders use one method by default and switch for specific deals. That's fine, as long as the note states the method clearly and your servicing records follow it.

• Is my capital actually sitting idle for the holdback, or deployed elsewhere until it's drawn?
• How large is the holdback relative to the loan?
• What do borrowers in my market expect?
• Am I pricing points and rate with the interest basis in mind?
• Can I calculate and explain the per diem accurately on either basis?

Getting the servicing right

Drawn balance interest is where calculation mistakes creep in. Every funded draw changes the balance, so it changes the per diem from that date. Payoffs must account for each draw's funding date. If you're tracking this by hand, a missed draw date can throw off a payoff by hundreds of dollars.

Full commitment interest is easier to compute but still needs care: confirm whether the note charges full commitment from closing or from a later date, and make sure any partial principal paydowns are handled as the note describes.

Disclose it clearly

Whichever method you use, state it plainly in the term sheet and the note, and walk the borrower through it. Surprises about interest basis are a common source of disputes at payoff. This guide is general information, not legal advice.

How it affects your payoff

The interest basis shows up most clearly at payoff. On a full commitment loan, the payoff is usually straightforward: interest on the full amount through the good-through date. On a drawn balance loan, the payoff has to account for every funded draw from its own funding date, and for any undrawn holdback that will never be lent.

If a borrower finishes early and doesn't draw the full holdback, a full commitment loan still charged interest on that money; a drawn balance loan did not. Make sure your note says what happens to unused holdback and whether interest already charged on it is refunded.

Changing the basis mid-loan

Occasionally a lender and borrower agree to change the interest basis during a loan, for example as part of an extension. If you do, document the change and its effective date in writing, and make sure your records accrue on the old basis before that date and the new basis after it.