What is the difference between serviced and capitalised interest?

Serviced interest is paid in cash as it falls due, usually monthly, from the borrower's own funds or the property's income. Capitalised interest is added to the loan balance instead, and repaid with the principal when the project sells or is refinanced. Capitalising preserves the developer's cash during the build, but the debt grows by the interest and by interest on that interest, and the limit has to be large enough to hold it.

Does capitalised interest compound?

Yes. Once a month's interest is added to the balance, the next month's interest is charged on it too. On a short development loan the effect is modest against the interest itself, about US$18,000 of US$529,000 in this page's example, but it grows with the term and the rate, and it is largest when the debt is fully drawn and settlement is late.

Is capitalised interest included in the loan-to-value ratio?

Usually, yes. Development lenders commonly measure loan to cost and loan to end value on the whole facility, including the interest that will be added to it by completion, rather than on the first advance. A loan that starts well inside its limit can reach it by the end through interest alone, so the ratio that matters is the one at the expected repayment date.

What happens when the interest allowance runs out?

The loan cannot hold more interest without exceeding its limit. Facility agreements commonly require the developer to fund the gap, by paying interest in cash or injecting equity, before the lender advances anything further; some lenders agree an increase or an extension, usually with a fee and a fresh valuation. Which happens is the lender's decision, and it depends on how far the project is from repaying.

// WORKED EXAMPLETHE ARITHMETIC A DECISION RESTS ON

Capitalised Interest: a Worked Example

The loan pays its own interest, and the bill arrives at settlement.

BY MICHAEL SHANG · SIXTEEN YEARS IN COMMERCIAL BANKING · UPDATED 2026-11-07

// THE SHORT ANSWER

Capitalised interest answers a practical question in development lending: who pays the interest while the building earns nothing? The loan does. Each month's interest is added to the balance and from then on carries interest itself, so the debt at completion is larger than the money spent on land and construction. The lender's job is to size that cost before the first draw, from the build programme, the drawdown profile and the rate, and to fit it inside the facility limit through to the settlements that repay it. Its risk is time: every month of delay adds interest and nothing to sell.

BASIS Practitioner judgment from sixteen years in commercial banking, set out in How Bankers Think (Highbank Press, 2026). Every borrower on this site is a composite constructed for teaching, not a client. The market is mid-market commercial lending as practised in New Zealand and Australia; where a convention differs elsewhere, the page says so.

// MAKE THE CALL

Issue 08 — Basalt Ridge Developments. A new-to-bank developer, a claimed 28% ROE and two other banks circling. Your bank has a growth target. Your call first, then the senior banker's.

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// 01 — WHY A DEVELOPMENT LOAN FUNDS ITS OWN INTEREST

A development has no income until units are sold or let. A developer could pay the interest each month from its own cash, but that cash would then sit outside the project budget, and the lender would be relying on the developer's other resources for every payment. Adding the interest to the loan keeps the whole cost of the project in one place. The facility limit then shows the debt as it will stand on completion, and the lender can test that figure against what the finished project will sell for.

Lenders describe the choice in different words. Interest is serviced when the borrower pays it as it falls due, capitalised or rolled up when it is added to the balance, and, in some UK short-term lending, retained when the expected interest is deducted from the advance at the start. Development loans in all three markets commonly capitalise; an investment loan secured on a let building usually expects the rent to service the interest.

// 02 — HOW IT IS CALCULATED

Interest this month = balance at the start of the month × monthly rate

Balance this month = opening balance + interest + this month's draw

Facility limit = land + construction + fees + interest allowance

Two things make the figure larger than a quick estimate suggests. Interest is charged on what has been drawn, and draws follow the build, so the balance is small early and at its peak in the final months, when each month's interest is largest. And because last month's interest is now part of the balance, the interest compounds. A lender, or the quantity surveyor it relies on, models the loan month by month from the construction programme rather than applying a rate to an average.

// 03 — THE EXAMPLE

A developer, constructed for this page, is building twelve warehouse units for sale. The lender advances US$2.0m towards the land at the start and US$6.0m of construction in equal monthly draws of US$500,000 over twelve months. The rate is 8.4% a year, 0.7% a month, capitalised monthly. The plan has every unit settled in month 14. The rate and the programme are the example's.

Land advance, month 0 2,000,000

Construction, months 1–12 6,000,000

Interest to settlement in month 14 529,000

of which interest on interest 18,000

Balance at settlement 8,529,000

Interest in month 1: 2,000,000 × 0.7% = 14,000

Interest in month 14: balance × 0.7% ≈ 59,000

The lender approves a limit of US$8.6m, an interest allowance of US$600,000 against the US$529,000 modelled. Then the programme moves:

Interest Balance Over the limit

As planned, settle month 14 529,000 8,529,000 —

Build four months late, month 18 682,000 8,682,000 82,000

Built on time, sales settle month 20 894,000 8,894,000 294,000

Month for month, the late build costs less. Four months of slower building, here sixteen draws of US$375,000, add US$153,000, about US$38,000 a month, because the draws are spread and the balance peaks later. Six months of late settlement add US$365,000, about US$61,000 a month: the whole debt is drawn, and each extra month costs more than four times the first. The end value moves the other way. Against an end value of US$12.0m the planned balance is 71%; at month 20, with prices 5% lower, it is 8.894 ÷ 11.4 = 78%.

// 04 — HOW IT DIFFERS FROM CAPITALISED BORROWING COSTS

The same words describe an accounting treatment, and readers confuse the two. In the developer's accounts, interest can be added to the cost of the asset being built rather than charged against profit. Under IAS 23, adopted in New Zealand and Australia as NZ IAS 23 and AASB 123, borrowing costs directly attributable to a qualifying asset, such as units that take a substantial time to build, must be included in its cost by a developer whose accounts follow those standards. Under FRS 102, which most UK mid-market groups use, capitalising them is a policy choice (paragraph 25.2), applied consistently to a class of assets, and a developer may expense them instead.

The two are independent. A loan whose interest is paid monthly in cash can still have that interest capitalised in the accounts, and interest rolled up into a loan can be expensed. A lender reading a developer's accounts checks the policy note, because capitalised borrowing costs sit in the stock figure and reach the profit and loss account only as cost of sales when the units sell, which makes interest cover on reported earnings look stronger than the cash suggests while the build is under way. The budget line that holds the loan's own interest is the interest reserve.

DEFINED IN ONE PARAGRAPH → · CAPITALISED COSTS → · DRAWING A DEVELOPMENT LOAN →

// 05 — WHERE IT DECIDES A FILE

Capitalised interest decides the limit and the ratios measured on it. Loan to cost and loan to end value are usually tested on the whole facility, interest included, so a lender that models interest too thinly approves a loan that is larger, by completion, than the ratio in the credit paper. The questions are about time: how long the build will really take, how long the units will take to settle, and what a rate rise would add if the loan is floating. Some lenders test the interest to the end of a realistic sell-down rather than to practical completion, because the settlements are what repay the debt.

When the allowance runs out, facility agreements commonly treat the shortfall as cost to complete, which the developer funds before the lender advances more. That is a conversation better held at approval than in month 19. In the Issue 08 file, the feasibility capitalises interest over a twenty-month term, and the unsold units are the second way out.

PROPERTY DEVELOPMENT FINANCE → · THE RESIDUAL STOCK LOAN → · LOAN TO GROSS DEVELOPMENT VALUE →

// SOURCES

The documents the statements on this page rest on. Each was opened and checked when cited.

IFRS Foundation, IAS 23 Borrowing Costs — summary of the standard — States that borrowing costs directly attributable to the acquisition, construction or production of a qualifying asset form part of the cost of that asset, other borrowing costs being expensed — section 04.
Financial Reporting Council, FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland, September 2024 — section 25, paragraph 25.2 — Lets an entity adopt a policy of capitalising borrowing costs directly attributable to a qualifying asset, applied consistently to a class of assets, and otherwise requires all borrowing costs to be expensed — section 04.

// QUESTIONS PEOPLE ASK

What is the difference between serviced and capitalised interest?: Serviced interest is paid in cash as it falls due, usually monthly, from the borrower's own funds or the property's income. Capitalised interest is added to the loan balance instead, and repaid with the principal when the project sells or is refinanced. Capitalising preserves the developer's cash during the build, but the debt grows by the interest and by interest on that interest, and the limit has to be large enough to hold it.
Does capitalised interest compound?: Yes. Once a month's interest is added to the balance, the next month's interest is charged on it too. On a short development loan the effect is modest against the interest itself, about US$18,000 of US$529,000 in this page's example, but it grows with the term and the rate, and it is largest when the debt is fully drawn and settlement is late.
Is capitalised interest included in the loan-to-value ratio?: Usually, yes. Development lenders commonly measure loan to cost and loan to end value on the whole facility, including the interest that will be added to it by completion, rather than on the first advance. A loan that starts well inside its limit can reach it by the end through interest alone, so the ratio that matters is the one at the expected repayment date.
What happens when the interest allowance runs out?: The loan cannot hold more interest without exceeding its limit. Facility agreements commonly require the developer to fund the gap, by paying interest in cash or injecting equity, before the lender advances anything further; some lenders agree an increase or an extension, usually with a fee and a fresh valuation. Which happens is the lender's decision, and it depends on how far the project is from repaying.

THE IN-TRAY · ONE MINUTE

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A short file on the ground this page covers. Every option opens with how far it sits from a senior banker’s read.

THE NUMBER · THE ECONOMY · COLLATERAL MARKETS

An office building earns US$1.0m a year of net operating income. Buyers price such buildings at a 5% yield, so it is valued at US$20m. The loan against it is US$12m.

If the yield buyers want rises to 6%, what is the loan-to-value?

3 MORE ON THE ECONOMY · COLLATERAL MARKETS →WHERE DO YOU READ FROM? THE PLACEMENT →

THE GLOSSARYIN ONE PARAGRAPHCapitalised interest (funded interest) What is capitalised interest, and why does it make a development loan grow?