Gap Funding for Real Estate Deals
Gap funding fills the hole between what your primary lender will provide and the total capital needed to complete a real estate deal. Most hard money lenders fund 80-90% of the purchase price and 100% of the rehab, but that still leaves a down payment, closing costs, and potentially holding costs that must come from somewhere. Gap funding is that somewhere.
When gap funding is needed
Consider a typical fix-and-flip scenario:
Gap Funding Example
Purchase price: $150,000
Rehab budget: $40,000
Total project cost: $190,000
Hard money loan (85% of purchase + 100% rehab): $127,500 + $40,000 = $167,500
Closing costs and reserves: $8,000
Total needed: $198,000
Gap: $198,000 - $167,500 = $30,500
The $30,500 gap represents the down payment on the hard money loan plus closing costs and reserves. Without gap funding, you need this cash out of pocket. With gap funding, a second lender provides this capital, allowing you to do the deal with little or no personal capital.
How gap funding is structured
Gap funding is typically a second-position loan secured by the property behind the primary hard money lender's first-position lien:
- Position: Second lien (behind the hard money first mortgage)
- Amount: The difference between the primary loan and the total project cost (typically $15,000-$75,000)
- Interest rate: 12-18% (higher than the first-position loan because of the increased risk)
- Term: Matches the primary loan term (6-12 months)
- Repayment: Paid off when the property is sold or refinanced, after the first-position lender is repaid
Sources of gap funding
- Private lenders: Individual investors willing to take a second-position lien for higher returns. See our guide to finding private lenders.
- Gap funding companies: Specialty lenders that provide second-position loans specifically designed to complement hard money first liens
- Business lines of credit: Credit lines from banks or online lenders (Kabbage, Fundbox) can serve as gap funding without requiring a lien on the property
- Cross-collateralization: Using equity in other properties you own as security for the gap amount
- JV partners: A joint venture partner who provides the gap capital in exchange for a share of the profit rather than a fixed interest rate
- Self-directed IRA lenders: Individuals lending from their retirement accounts for the higher yield
Risks and considerations
Hard money lender approval
Many hard money lenders prohibit second liens on the property. They want to be the only creditor with a security interest. If you use gap funding through a second-position lien, verify that your primary lender allows it. Some lenders will allow a subordinate lien from an approved gap funder but not from an unknown private lender.
Increased cost of capital
Adding gap funding increases your total interest expense. If you are paying 12% on the first and 15% on the gap, your blended rate is higher than either loan alone. Make sure the deal's profit margin can absorb both interest expenses and still leave adequate return.
Risk to the gap lender
The gap lender is in second position, meaning they only get paid after the first-position lender is fully satisfied. If the deal goes badly (cost overruns, market decline, extended holding period), the gap lender may not recover their full investment. This risk is why gap funding carries higher interest rates.
Gap funding vs bringing your own cash
Using gap funding allows you to do more deals simultaneously (your capital is not tied up in any single deal) but reduces your profit per deal due to the additional interest cost. The tradeoff makes sense when:
- You have more deals than capital
- The deals have strong margins that can absorb the additional financing cost
- You want to scale your operation faster than your personal capital allows
Related articles
- Hard Money vs Private Money
- Transactional Funding Guide
- Proof of Funds: What Buyers Need
- How to Find Private Lenders