Gap funding for real estate investors generally comes in the form of a second-position loan to cover the difference between the amount funded by a Hard Money Lender (HML) and the total amount needed to fund the deal (cash to close). We haven’t had to use it yet, but as our volume picks up, we may have to look into it.
Gap Funding isn’t for everyone – it’s mostly used by experienced investors and builders who, for the most part, are dealing with higher end properties, and even then only in certain situations:
- A rehab project has gone behind schedule and/or has used up its initial budget and is still not completed.
- A property has taken longer than expected to finish and is now sitting on the market, but the investor still has to make monthly interest payments.
- A deal is expected to be completed quickly and the investor needs to keep their reserves liquid in case another opportunity comes along and they need to react quickly.
Gap Funding is also used on wholesale deals. In a back-to-back or same-day close, an investor must first purchase a property; they then immediately sell the same property to a cash buyer for a profit. In states where state law requires the investor to fund the first transaction before they can sell the property, it makes sense to leverage “other people’s money” to finance deals. This is where gap funding (or “transactional funding“) comes into play.
Most gap loans build the interest payments into the loan itself, with the expectation that the principle and interest will all be repaid when the deal closes. Depending on the market and the property, rates can vary widely. The lender is assuming higher risk, so rates will be accordingly higher and the periods can be surprisingly short term. Don’t be surprised if the loan is structured so that interest rates increase over the life of the loan. Example: 8% paid back within 90 days, 10% within 120 days, and 12% within 150 days.