What is a Debt Service Reserve?
Learn what a debt service reserve is, when lenders require reserve accounts, and how maintaining reserves protects your business during cash flow disruptions.
A debt service reserve is a cash reserve account that holds funds to cover loan payments if your business experiences a temporary cash flow shortfall. Lenders may require you to establish and maintain a reserve as a condition of the loan to ensure payments can continue even during difficult periods.
How Debt Service Reserves Work
When required, a debt service reserve is typically structured as:
- Dedicated account: A separate savings or escrow account
- Funded amount: Usually 3-12 months of loan payments
- Restricted use: Funds can only be used for debt service
- Maintained balance: You must keep the account at the required level
Common Requirement
A typical reserve requirement is 6 months of principal and interest payments. For a loan with $5,000 monthly payments, this would mean maintaining $30,000 in reserve.
When Reserves Are Required
Lenders are more likely to require debt service reserves for:
- Commercial real estate loans
- SBA 504 loans (CDC portion often requires reserves)
- Businesses with seasonal or cyclical revenue
- Borrowers with marginal DSCR (near the minimum threshold)
- Construction loans during the build-out phase
- Newer businesses with limited operating history
Funding the Reserve
Reserves can be funded in different ways:
- From loan proceeds: Reserve amount is included in the loan and deposited at closing
- From existing cash: You fund the reserve from your own capital
- Built over time: Some lenders allow you to build reserves gradually from operations
Reserve Covenants
Your loan agreement will specify reserve requirements:
- Minimum balance that must be maintained
- Frequency of balance verification
- Conditions under which reserves can be drawn
- Replenishment requirements if reserves are used
- Consequences of failing to maintain required reserves
Benefits of Reserves
While reserves tie up cash, they provide important benefits:
- Protection during temporary cash flow disruptions
- Demonstrates financial discipline to lenders
- May enable approval that would otherwise be denied
- Reduces stress during slow periods
- Often counts toward overall financial qualification
Even if not required by your lender, maintaining your own debt service reserve is a prudent business practice. Having 3-6 months of loan payments in reserve provides valuable peace of mind.
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Read more →Important Disclosure
Not Financial Advice: The information provided in this article is for general informational purposes only and does not constitute financial, legal, or professional advice. You should consult with qualified professionals before making any financial decisions.
No Guarantee of Financing: Liminal Lending Co. is a business loan marketplace that connects borrowers with third-party lenders. We are not a lender and do not make credit decisions. Submitting an application does not guarantee approval or funding. Loan terms, rates, and availability vary by lender and are subject to borrower qualifications and lender criteria.
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Rate Information: Rates, terms, and fees mentioned in this article are estimates based on publicly available information and may not reflect current market conditions or specific lender offers. Actual rates depend on creditworthiness, business financials, and lender policies.
Information May Change: Financial markets, lending regulations, and economic conditions are subject to rapid change. While we strive to keep our content accurate and up-to-date, information in this article may become outdated. Always verify current rates, terms, program availability, and regulatory requirements with lenders and official sources before making financial decisions.