What is a Debt Service Fund?

A debt service fund is a cash reserve that is used to pay for the interest and principal payments on certain types of debt.

Advantages of a Debt Service Fund

The existence of a debt service fund is intended to reduce the risk of a debt security for investors, since it ensures that funds are being set aside to meet the borrower’s debt obligations. It also enhances the accountability of the borrower, which is being forced to set aside a portion of its earnings to make the designated debt payments. Because of this accountability, it makes the debt offering more attractive to investors, which may reduce the effective interest rate needed to sell the offering.

Disadvantages of a Debt Service Fund

A clear disadvantage of a debt service fund is that it ties up a portion of the cash that the debt issuer receives from the debt offering, so that it cannot be applied to more useful investments. This reduces the usefulness of the debt issuance to the borrower.