Interest Roll-Up in Development Finance: How Capitalised Interest Works

Interest roll-up, also known as capitalised interest or retained interest, is the standard method of handling interest payments in UK development finance. Instead of making monthly interest payments to the lender during the construction period, the interest accrued each month is added to (rolled up into) the outstanding loan balance. The total interest is then repaid along with the principal when the development completes and the loan is redeemed through unit sales or refinancing.

This approach exists because development projects do not generate income during construction. A developer building 10 houses over 18 months has no rental income and no sales proceeds until the properties are completed and sold. Requiring monthly interest payments would therefore create a significant cash-flow burden during the period when the developer's capital is fully deployed in the build. By rolling up interest, the lender allows the developer to focus all available cash on construction, with the cost of borrowing deferred until the project generates revenue.

The practical effect of interest roll-up is that the loan balance grows throughout the build period. If you draw down £1 million on day one at 8% per annum, after one month the balance becomes approximately £1,006,667 (including one month's interest). After 12 months, the balance is approximately £1,083,000. After 18 months, it reaches approximately £1,124,000. The £124,000 of accumulated interest must be repaid alongside the original £1 million principal. This compounding effect means that the total cost of borrowing is higher than it would be under a serviced interest arrangement, which is the trade-off for having no monthly payment obligations during the build.

The mathematics of interest roll-up follow a compounding pattern because interest accrues not only on the original principal but also on previously accrued interest. This compound interest effect is modest over short periods but becomes increasingly significant on longer facilities or higher-value loans. Understanding how compounding works allows you to accurately model your total finance costs and ensure your development appraisal reflects the true cost of borrowing.

Consider a development facility with a £2.5 million maximum, drawn in stages over 15 months. The land tranche of £1 million is drawn on day one. A further £500,000 is drawn at month three, £400,000 at month six, £350,000 at month nine, and £250,000 at month twelve. At an interest rate of 8.5% per annum with monthly compounding, the total rolled-up interest by month 15 is approximately £215,000. This represents roughly 8.6% of the total facility and must be budgeted as a cost within your development appraisal.

A common error we see in development appraisals is calculating interest as a simple flat percentage of the total facility for the full term. A developer might estimate interest at 8.5% of £2.5 million for 15 months, producing a figure of £265,625. But because funds are drawn in stages and interest only accrues on drawn amounts, the actual cost of £215,000 is lower. Conversely, we also see developers who underestimate interest by applying the rate only to the initial drawdown without accounting for subsequent draws. Getting this calculation right, by modelling interest on a month-by-month basis against the actual drawdown schedule, is essential for an accurate appraisal. Our team models interest to the penny for every deal we arrange, and we recommend all developers do the same.

When a lender approves a development facility, they do not simply agree to lend the construction costs and hope there is enough headroom to cover interest. Instead, the facility includes an interest retention, sometimes called an interest reserve, which is a portion of the total facility set aside to cover the expected interest charges over the loan term. This retention reduces the amount of the facility available for actual construction costs.

For example, a lender might approve a total facility of £3 million, structured as: £1 million for land acquisition, £1.7 million for construction costs, and £300,000 retained for interest. The developer can draw down the land and construction tranches as needed, but the £300,000 interest retention is never physically drawn. Instead, it sits as an accounting entry that is released month by month to cover the accruing interest. At the end of the facility, if actual interest charges are £280,000, the unused £20,000 of retention is released back, and the developer only repays what was actually used.

The size of the interest retention is calculated based on the lender's assumptions about the drawdown profile and the expected loan term. If the project takes longer than expected, the interest retention may be insufficient, creating a situation where additional funds are needed to cover the shortfall. This is one of the reasons why building programme accuracy is so critical. A three-month delay on a £3 million facility at 8.5% could generate an additional £63,750 of interest that was not budgeted in the original retention. We always stress-test interest retentions against a delayed completion scenario to ensure our clients have adequate headroom. Submit your project details through our deal room and we will model the interest cost under both base-case and downside scenarios.

While interest roll-up is the norm in development finance, some lenders offer the option of serviced interest, where the borrower makes monthly interest payments during the build period. This approach is relatively uncommon in development lending but is worth understanding because it can reduce the total cost of borrowing for developers who have the cash flow to support monthly payments.

The cost saving from serviced interest is real but modest. On a £2 million average drawn balance at 8% over 18 months, rolled-up interest with monthly compounding totals approximately £254,000. If the same interest is serviced (paid monthly), the total interest charge is approximately £240,000 because there is no compounding effect. The saving of £14,000 represents about 5.5% of the total interest cost. Whether this saving justifies the cash-flow commitment of monthly payments depends entirely on the developer's financial position.

In our experience, serviced interest is only practical for developers with substantial cash reserves or other income streams that can cover the monthly payments without diverting resources from the construction programme. A monthly interest payment on a £2 million drawn balance at 8% is approximately £13,333, which is a significant recurring commitment. For most developers, particularly those on their first or second project, the cash-flow flexibility of rolled-up interest far outweighs the modest cost saving from servicing. We generally recommend rolled-up interest unless a developer specifically requests otherwise and can demonstrate the cash-flow capacity to sustain monthly payments. For more on how different interest structures fit within the broader capital stack, see our guide on the capital stack in property development.

Rolled-up interest is a significant cost line in any development appraisal and directly impacts your profit margin. Because the interest compounds and grows throughout the build period, delays in construction or sales have a multiplied effect on profitability. Every additional month the loan remains outstanding increases the total interest charge and reduces the developer's profit. This time-cost relationship is one of the most important dynamics in development finance and should inform every major decision on the project.

On a scheme with a GDV of £4 million and total costs of £3.2 million, the target profit is £800,000 (20% on GDV). If rolled-up interest is budgeted at £200,000 within those costs but actually comes to £280,000 due to a three-month delay, the developer's profit drops to £720,000 (18% on GDV). That may still be acceptable, but consider that the delay might also require an extension fee on the facility (typically 1-2% of the outstanding balance), adding another £30,000 to £60,000. Suddenly the profit is £660,000 to £690,000 (16.5-17.25% on GDV), which is below many lenders' minimum threshold and represents a material reduction in the developer's return.

We advise developers to model a worst-case interest scenario alongside their base case. Add three months to your expected programme, include extension fees, and calculate the impact on your margin. If the project still delivers an acceptable return under the stress case, your appraisal is robust. If the stress case pushes you below 15% on GDV, you may need to revisit your build programme, your contractor's ability to deliver on time, or your exit strategy. Building a more conservative interest budget from the outset is always preferable to discovering a shortfall when the project is half-built and options are limited.

The single most effective way to minimise rolled-up interest is to complete the development as quickly as possible. Every month shaved off the build programme reduces the period over which interest compounds. A developer who completes a project in 12 months instead of 15 months can save 20-25% on total interest costs, which on a £3 million facility at 8% could represent £40,000 to £60,000. Appointing a reliable contractor with a proven track record of on-time delivery is therefore one of the most impactful financial decisions a developer can make.

Selling or refinancing as early as possible is the second lever. If you can begin selling completed units while the build is still in progress, the sales proceeds can be used to partially repay the development loan, reducing the outstanding balance and therefore the interest accruing. Many development facilities allow partial redemptions without penalty, meaning that each unit sold immediately reduces your interest cost. On a 10-unit scheme where the first four units complete two months before the final six, selling those four units early could reduce the average loan balance and save £15,000 to £25,000 in interest over those two months.

Finally, consider the timing of your drawdowns. As discussed in our guide on drawdown schedules, delaying each drawdown until funds are genuinely needed reduces the average drawn balance and therefore the total interest cost. If your contractor can wait 14 days for payment after stage completion, request your drawdown 10 days after completion rather than immediately. The accumulated savings from disciplined drawdown timing across a multi-stage facility can be substantial. These strategies require attention to detail and proactive management, but the financial rewards are meaningful.