Gap funding is essentially an interim loan used to temporarily provide financing for an individual until they can secure a more permanent solution. Otherwise known as a bridge loan, gap funding is traditionally used to “bridge the gap” between the moment a borrower needs money and when they are actually able to secure a long-term loan.
Due, in large part, to their short-term nature, gap loans are traditionally used by borrowers who are simultaneously waiting for long-term financing to clear and in need of money to cover immediate expenses; it’s become a great tool for anyone who needs access to capital while they are waiting for a subsequent loan to transpire. As a result, more and more real estate investors are starting to take advantage of gap lending, and the benefits it may provide between deals.
Most real estate investors will rely on private money or hard money loans for impending deals. However, it’s uncommon for most private and hard money lenders to cover the entire cost of the purchase and rehab. Most lenders, for example, will only lend a percentage of the purchase price or after-repair-value (ARV)—usually somewhere around 70% of the home’s value. As a result, most borrowers will need to secure additional capital; that’s where gap funding comes into play.
Gap funding for real estate investors can make up for the shortcomings of most hard money lenders. More importantly, gap money may cover the difference between the original hard money loan and the remaining cost obligations. That means gap funding for real estate investors may cover the rest of the acquisition costs, in addition to the costs incurred from rehabbing, marketing, and selling the property.
It is worth noting, however, that gap loans typically coincide with more expensive rates than their private and hard money counterparts. Since gap loans are technically a second position loan (behind the original loan), they’ll compensate for the added risk with higher rates. Additionally, gap funding lenders may also require borrowers to hand over a percentage of the deal’s resulting profits. While gap funding has helped countless real estate investors carry out deals they may not have otherwise had the chance to, it must be used conservatively.
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Gap funding serves a very specific purpose, and is best suited for investors flipping a high volume of properties. That said, there are other benefits investors will be very happy to hear:
Gap funding is tailor made for high-volume rehabbers, as it is ideal for those who fully intend to maintain several projects at once. More specifically, however, gap funding mitigates the risks one may encounter from a delayed sale, or any instance that unexpectedly slows down the rehab process. With gap funding, the need to wait for one deal to close before starting another one becomes obsolete.
Gap funding for real estate investors may cover the difference hard money loans and the remaining acquisition costs of subject property. As a result, gap funding makes it possible for many investors to acquire deals they otherwise wouldn’t have been able to.
Gap money can help investors fund more than the acquisition of a property; it can be used to rehab costs, and any costs incurred from trying to sell and market the home.
Gap funding has proven very useful for investors who want to remain a more liquid position.
Despite how useful gap funding has proven to be for investors, it is very situational. While it may serve as a great source of interim funding, there are some drawbacks investors need to pay special considerations to:
The short-term nature of gap funding makes it less ideal for investors attempting to flip a single deal. The added costs are typically meant to meet the needs of those who intend to flip a high volume of properties simultaneously. Therefore, the cost of a gap loan may not be worth the price of admission for those who won’t use the funds under the right circumstances.
Due to the increased risk facing gap lenders, investors can expect to pay more in interest. Typically, the rate will be upwards of 1% higher than more traditional mortgages.
While not standard, some gap lenders will request a percentage of the proceeds from the sale of the house.
Receiving a gap loan—not unlike almost every other source of funding—will require investors to decide whether they want to pursue traditional or alternative forms of funding. If for nothing else, gap loans are made available from both institutionalized banks and private money lenders. Those who elect to borrow from a traditional bank will need to apply, a lot like a regular loan. Those who would rather work with private or hard money lenders will need to attract interested investors. Since gap lending is technically riskier, investors will need to convince the gap lenders that their investment would be worthwhile. Not unlike a hard money loan, the money received from gap lenders is more asset-based than anything else. That means, the better the deal, the more likely they will be to lend the money.
Gap lending and real estate investing go hand-in-hand. Better yet, gap lending serves as the perfect financial safety net for those who may need to keep current projects going or don’t want future project to be put on hold because of current delays. Gap funding, for example, may help those who have spent all of the money from their original hard money loan, but still need more to complete the rehab. Instead of delaying the project and risking losing profits, investors may secure gap funding to finish renovations. Sure, the loan will come with added costs, but they are well worth the price of admission if they help see a deal through to completion.
Gap funding has developed a reputation for supplying borrowers with immediate access to capital. It is worth noting, however, that gap funding is more than a source of money; it’s a tool used by countless investors to facilitate deals they may have otherwise had to pass on. That said, gap funding isn’t without its caveats; there is a right and a wrong time to use it. Therefore, it’s in everyone’s best interest to learn everything they can about gap lending before committing to it.