Serviced interest in a property development loan refers to a method of interest payment where the borrower pays the interest on a monthly basis. This is one of the most common arrangements for property development loans and is known for its simplicity. Essentially, the borrower pays interest on the borrowed amount each month.
With serviced interest, the lender will calculate the interest due on the loan each month and then collect it from the borrower. The borrower will then be responsible for paying the interest to the lender on a monthly basis. This raises the question: what is the precise amount of interest that the borrower needs to pay each month?
Common ways to calculate serviced interest
If the lender is charging interest on the full loan amount, here we assume a £5,000,000 loan, an annual interest rate of 10% and a loan term of 12 months, the calculation is as follows:
Serviced interest on full loan amount
= Total facility x interest rate (monthly) x number of months
= £5,000,000 x 10%/12 x 12
= £500,000
However, a lot of the time, the borrower does not utilise the full loan amount on day 1, especially for a property development loan. In general, monthly construction costs gradually increase to peak in the middle of the construction period and then gradually fall towards the end. We call this assumption an ‘S-curve’ distribution. Read this blog for a more detailed explanation.
Therefore, a common industry practice is to divide the total facility in half and then proceed with the regular interest calculation. By halving the total facility, we can take into account the S-curve loan drawdown and its impact on the calculation. Using the example above, the calculation for interest when it is charged on loan drawdown would appear as follows:
Serviced interst on drawn balance
= Total facility/2 x interest rate (monthly) x number of months
= £5,000,000/2 x 10%/12 x 12
= £250,000
However, it is important to note that the loan drawdown does not always follow a perfect S-curve. In reality, there may be instances where it does not resemble an S-curve at all. For example, you might have significant costs incurred in specific months, such as during the site purchase phase. When it comes to property development, profitability relies on tight margins. Therefore, it is crucial to have the most accurate forecast possible in a development appraisal. What you truly need is a precise calculation of the exact amount of serviced interest each month, taking into consideration the costs incurred and the actual loan drawdown.
Calculate serviced interest with Aprao based on a cashflow
Let’s continue to use the example above, a £5,000,000 loan with an annual interest rate of 10%. To calculate the serviced interest based on the cashflow, you would need to create a cashflow in the first place. Aprao's smart cashflow feature is designed to make this process easy, even for those without prior experience in Excel or anyone looking for a quicker solution. Click here to sign in and follow along with these instructional videos to build a cashflow in a few simple steps.
After creating a cashflow for your appraisal, go to the finance tab and input the total facility of the loan that you are getting. Then, you have the option to choose between 'Retained', 'Rolled-up' and 'Serviced' as your loan’s interest type for interest calculation purposes. After choosing ‘Serviced’, select the option for interest on 'Drawn balance’ instead of 'Full loan amount'. Next, input the interest rate and select ‘Cahsflow’ as the basis for the interest calculation. The estimated interest amount will then be calculated and shown.
The interest amount shown here is the total amount of serviced interest that you will pay throughout the loan period. To know the precise amount of interest that you will pay for each month, go to the cashflow tab. At the bottom, you will see a row named ‘Serviced interest payment’. It shows the exact amount of interest payment based on that month’s loan drawdown.
In case you need to export this information, click ‘EXPORT’ on the top right corner of the cashflow tab to download the cashflow in a spreadsheet format. With Aprao, you are able to build and manage your appraisal from start to finish on the platform, easily share and collaborate with anyone on the cloud and generate a report that is ready to be submitted to lenders or any stakeholders.
Read this blog series on interest types - rolled-up, retained and serviced. Read this complete guide on how to incorporate development finance into your project.
Want to follow along and create your own appraisal? Existing customers can log in here and new customers can click here to sign up for a free 14 day trial of Aprao.
Leave a comment