Gap funding for real estate investors fills the financial gap that arises when the amount provided by a hard money lender is not enough to cover the full cost of a real estate project.
Hard money loans typically only finance 70% to 80% of a property’s purchase price, leaving the investor to provide the remaining 20% to 30% for a down payment and closing expenses. Although hard money lenders may finance 100% of renovation costs, they usually require the investor to pay for each phase of repairs before reimbursing them in increments.
This can result in a large number of personal funds required to flip a property or undertake a BRRRR method. To address this, real estate gap financing can be obtained from a secondary source to provide additional financial support.
In this post, we’ll provide everything you need to know about gap funding for your real estate project.
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How Can Gap Funding be Used?
Gap finance makes it possible to buy and sell a home with little or no initial capital. However, its applications go beyond just investing other people’s money.
Flippers sometimes need an immediate infusion of cash when refurbishment costs exceed initial estimates. Alternately, if the remodeling takes longer than planned, it will put a strain on their ability to pay the mortgage.
Sometimes investors have most of their funds committed to a different rehab but come upon an offer they can’t refuse. In real estate, use leverage with caution. Greater leverage equals more potential loss in a property transaction. However, leverage may help you save a deal and make more money.
Real Estate Gap Funding Options
For those who invest in real estate, there are a variety of options for filling the gap in their financing, including consulting a positively geared book for valuable insights. The following are some potential sources of gap finance for real estate.
Gap Lenders
Gap financing is a service that certain lenders provide only to real estate investors. They take on a huge amount of risk because they put a second lien behind the hard money loan and lend a high loan-to-value (LTV) ratio. The result is sky-high interest rates and other costs. However, to recoup their losses, some gap finance providers may ask for a share of your deal’s eventual earnings.
Personal Loans
An alternative is to apply for a personal loan from a bank or other lender that doesn’t need you to put up any collateral. Some hard money lenders provide personal loans without collateral. To be clear, personal loans are not cheap. They pose a substantial risk to the lender unless they are secured by a lien on real property.
Private Notes
When starting, some real estate investors turn to their networks for funding. Private financing has several advantages, including its adaptability and negotiability. However, borrowing money privately from friends and family has the danger of straining personal ties and requires time and success to establish confidence.
HELOCs
A HELOC is a type of secured loan that may be taken out against the equity in your house or rental property.
These lines of credit function as revolving lines of credit, like a credit card. It’s there for you to use as you need it and put toward repayment as you see fit. That means you may utilize HELOCs as flexible finance sources for real estate down payments, closing expenses, and repair charges.
They have interest rates somewhere in the middle, between those of mortgages and gap loans or unsecured personal loans. However, because they place a lien on your home, you must employ a title company and pay thousands in closing charges.
Business Credit Lines
To qualify for a line of credit, a lien on your home may not always be necessary. As a real estate investor, you may also get unsecured company credit lines.
The interest rates will be higher, but the closing costs will be lower since there will be no title search or typical closing. However, as a company owner without goods or collateral, you may not be accepted for a large credit limit.
Business Associates
Finally, you may work with a partner who will contribute funds to the deal. Perhaps you can provide the knowledge, legwork, or another critical piece of the jigsaw. They provide the majority of the down payment and closing fees, while you negotiate a profit-sharing arrangement.
As the old financial adage goes, 50% of anything is better than 100% of nothing.
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Final Thoughts
If you’re close to completing your rehab and need one final push over the finish line, gap funding could be the solution. Remember that not all funding is created equal when it comes to the BRRRR method, and it’s important to understand the advantages and disadvantages of each type before deciding which one is right for you.