What Gap Funding is & How it Works with Other Loans
Gap funding can be used alongside hard money loans to cover the shortfall between the hard money loan amount and the total project cost. Gap funding can cover a portion of your down payment, renovation costs, and other unexpected expenses. However, some hard money lenders may not allow the use of additional loans to cover certain costs.
Real estate investors sometimes find that they do not have quite as much money as they need for a project. They might, for example, find that a property needs more work than they originally thought, or they might need extra funds to get them to the point when longer-term financing becomes available. Gap funding can provide extra cash to cover costs, meet obligations, or hold onto an investment opportunity.
Learn more about gap funding how it can work in conjunction with hard money loans, and how a well-crafted hard money loan can hopefully make gap funding unnecessary.
How is gap funding similar to hard money lending? How are they different?
Photo by U.S. Army Corps of Engineers on Flickr [Public domain]
The main similarity between gap funding and hard money lending is that they both come from private rather than institutional lenders. Neither is subject to many of the regulations and restrictions that govern banks and other more traditional lending sources. As a result, both gap and hard money lenders can offer a range of flexibility, with loans customized for an investor’s unique situation and needs.
Gap funding and hard money lending differ in numerous ways, such as the following:
| Gap funding | Hard Money Lending | |
|---|---|---|
| Purpose of Loan | To provide funds that cover a gap in financing, such as a shortfall in a down payment or cost overruns during a real estate project. The gap loan may be used to cover unexpected costs that your hard money lender won’t pay for. |
To provide funds for a real estate investment project, such as purchasing, renovating, and selling a property. |
| Loan term | Typically a few months to one year | Six months to two years, or longer in some cases |
| Interest rate | Often higher than the first-position loan, and can exceed 10% in many cases | Often around 10 to 12% |
| Lien position | Second position | First position |
When could I use hard money lending instead of gap funding?
One of the main benefits of gap funding for real estate investors involves helping them deal with the unexpected. A project might require more work than an investor initially thought. An accident or natural disaster, such as hail or tornado damage, might add to a project’s cost.
An experienced hard money lender may also be able to help in these kinds of situations without the help of gap funding.
Careful planning with the assistance of an experienced lender can help investors anticipate costs accurately and avoid budget overruns. In the event of unexpected and unavoidable setbacks, investors can work with hard money lenders to see if additional funding to an existing loan is possible. This can be simpler than seeking gap funding with stricter terms and higher interest rates.
Photo by Mark Hillary on Flickr [Creative Commons]
Gap funding is a type of loan that covers the “gap” between the available funds for a project and the project’s total cost. In the real estate investing context, a “project” could be anything from a fix-and-flip to a new development on raw land. An investor could use gap funding to help cover the purchase price of a property, or to cover obligations like property taxes or maintenance costs while waiting to close on a permanent loan. Borrowers may also use gap funding for a wide range of other purposes unrelated to real estate.
Institutional lenders like banks and credit unions offer gap funding, but borrowers often choose private lenders. Lenders generally perceive gap loans as being riskier than hard money loans and other kinds of private loans. As a result, gap funding loans have higher interest rates.
When an investor who already has an outstanding loan on a property gets gap funding, that loan usually takes a secondary position. The earlier loan, which could be a hard money loan, has the first lien position. In the event that the project is unsuccessful and goes into foreclosure, the first lien would get paid before the second. The gap lender would have to wait until the first lien is satisfied before receiving payment. This is a significant part of the greater risk in gap funding.
Use cases for gap funding by real estate investors
Photo by Nolan Issac on Unsplash
Investors may use gap funding for a variety of purposes. It can cover unforeseen expenses, carrying costs, and other obligations during a project. When an investor’s funds are tied up elsewhere, gap funding can allow them to take advantage of a new opportunity without having to wait for payouts from other projects. Examples of uses for gap funding in real estate investment include the following:
Covering costs when a project needs additional renovations or other work
Paying expenses like insurance and property tax while waiting for a property to sell or a permanent loan to close
Marketing a finished property for sale
Providing extra funds for a down payment on a property
Gap funding for down payments
Note: using a loan for a down payment is sometimes not allowed by certain lenders. It’s considered a risk indicator.
Real estate investors can use gap funding to obtain the funds needed to make a down payment on a property. They might not have enough cash on hand because of other active investments. Hard money lenders typically require 25% to 35% of the purchase price as a down payment. Down payment gap funding can be the difference between seizing an investment opportunity while it’s hot and seeing it slip away.
Viability gap funding
Gap funding can help investors involved in projects that offer long-term benefits but have short-term economic problems. Viability gap funding (VGF) typically occurs in public-private partnerships, such as when a private investor works with the government to develop land or renovate existing properties. These types of projects might not have quick financial returns, but they can have positive economic impacts over time. VGF gives private companies and investors an incentive to get involved.
Commercial gap funding
Businesses can use gap funding for a wide range of purposes. This might include real estate projects, research and development, and product rollouts. This type of gap funding is often effectively the same as bridge financing.
Learn more about hard money loans for real estate investors!
Capstone Capital Partners provides fast and flexible financing to real estate investors for a variety of projects throughout Texas. In fact, with an apprisal in hand, you can close in as fast as 7 days!
Our highly experienced, relationship-oriented team will evaluate your project and help you obtain the right kind of funding for your particular project.
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