What is gap funding in real estate?
Gap funding is capital provided by a private money lender to cover the gap between your down payment/available capital and the total funding needed for a real estate deal. It's typically structured as a second lien (subordinate to a first mortgage or hard money loan) and is used primarily for fix-and-flip projects, BRRRR deals, and bridge financing scenarios. The gap lender charges interest and points as compensation for the additional risk and shorter repayment timeline.
How does gap funding work for fix and flip projects?
Here's the typical structure: You find a fix-and-flip deal requiring $300k purchase + $50k repairs = $350k total. You have $50k down payment. A hard money lender provides $225k first lien. Gap funding fills the remaining $75k as a second lien. You close with $50k of your own cash plus the two loans. During the 6-month flip, you pay interest on both loans from your cash flow or rehabbing proceeds. When you sell for $450k, you pay off both loans from sale proceeds and keep the profit. Gap funding gets fully repaid at sale.
Is gap funding better than using my own cash?
Neither is universally "better"—it depends on your situation. Using your own cash means no interest costs but ties up capital, limiting deal flow. Gap funding costs interest and points but preserves capital for multiple deals, potentially improving overall portfolio returns. If you can deploy capital across 4 deals using gap funding vs. 1 deal with your own cash, the gap-funded portfolio may generate higher total returns despite individual deal costs. Use our calculator to compare both scenarios for your specific situation.
What ROI should investors expect with gap funding?
Typical fix-and-flip deals target 20-30% net profit margin and 30-50% annualized cash-on-cash return. With gap funding, you may see slightly lower net profit per deal (due to interest costs) but higher ROI on your actual cash deployed. For example: $100k cash invested using gap funding might yield $60k profit = 60% ROI. The same deal using all your own cash might yield $80k profit but require $150k capital = 53% ROI. The latter looks better on profit but actually lower on capital efficiency.
How do private money lenders price points and interest?
Private money lenders typically charge 1-5% points (upfront fees) and 10-15% annual interest. Points are calculated as a percentage of the loan amount—2 points on a $100k gap loan = $2,000 paid at closing. Interest accrues daily or monthly and is paid from sale proceeds. Pricing depends on several factors: loan-to-value ratio, project risk, your experience level, timeline, and current market conditions. Always get multiple quotes to compare—rates vary significantly between lenders.
Does gap funding reduce my risk?
Gap funding reduces capital risk (less of your own money at risk if deal fails) but increases debt risk (you owe the lender regardless of outcome). If your flip underperforms and you can't cover the gap loan payoff, you're personally liable. The net risk reduction depends on your overall portfolio strength and deal quality. Successful investors use gap funding strategically—on deals with strong fundamentals and high profit margins, not on marginal deals.
What is a typical gap funding profit split?
Traditional gap funding is NOT a profit split—it's debt financing. The lender receives principal repayment plus interest at closing. Some investors negotiate hybrid structures where the lender takes a small equity participation (e.g., 5-10% of profit) in exchange for better rates, but this is less common. Most gap funding relationships are straightforward: you borrow $X at Y% interest, and repay principal + accrued interest from sale proceeds, keeping all remaining profit.
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Why do investors use gap funding for BRRRR deals?
BRRRR stands for Buy, Rehab, Rent, Refinance, Repeat. Gap funding is perfect for this strategy because it bridges the purchase and rehab phase, then gets paid off at refinance. After rehab and rental, you refinance using the property's new appraised value and cash flow, pulling out your initial capital. This cycle repeats: each deal returns your cash to deploy on the next deal. Without gap funding, capital gets stuck in each property, limiting deal flow.
Can gap funding improve cash-on-cash return?
Yes, absolutely. By reducing your required cash deployment, gap funding can dramatically improve cash-on-cash return percentage. Example: A deal generates $60k profit. If you self-fund $150k, your cash-on-cash return = 40%. If you use gap funding and only deploy $75k, your return = 80%. The trick is that your total net profit may be lower (due to interest costs), but your return on actual cash deployed is higher. This capital efficiency is gap funding's primary advantage.
What are the risks of using gap funding?
Key risks include: (1) Higher total interest costs reduce profit; (2) Debt obligations exist regardless of project outcome—you must repay even if the flip underperforms; (3) Second lien position means if there's a foreclosure, first lien holder is paid first; (4) Extended holding periods compound interest costs; (5) If market shifts and property can't sell for projected price, you may struggle to cover loan payoff; (6) Personal liability if deal fails; (7) Complex underwriting with multiple lenders increases closing complexity.
How do I find reputable gap funders?
Look for lenders with: documented track record of closings, references from other real estate investors, clear written terms and conditions, transparent pricing, reasonable rates compared to market averages, and responsive customer service. Ask for their average time to close and examples of similar deals they've funded. Check reviews and references thoroughly. Jaken Finance Group specializes in gap funding and bridge loans for experienced investors. Get pre-qualified in minutes to understand available terms.
Does gap funding affect loan underwriting?
Yes. Gap funding increases your debt load, which affects your debt-to-income ratio on future loan applications. When refinancing a BRRRR property, the lender must account for both the first mortgage and the gap loan being paid off. Disclose all gap funding to your primary lender to avoid complications or loan denial. Some lenders won't approve cash-out refinances if your debt obligations are too high relative to the property's cash flow.
Should beginners use gap funding or their own cash?
Beginners should carefully weigh both options. Using your own cash on initial deals teaches you the business without debt pressure and allows you to absorb mistakes without jeopardizing relationships with lenders. As you gain experience, build capital, and develop a track record, gap funding becomes attractive for scaling. There's no universal answer—it depends on your capital availability, risk tolerance, and long-term goals. Use our calculator to model both scenarios for your specific situation.
What credit score do I need to use gap funding?
Gap funding is often asset-based (secured by the property) rather than purely credit-based, but lenders still review credit as one underwriting factor. Most lenders prefer 650+ credit scores, though some work with lower scores depending on deal strength and equity position. If your credit is below 650, focus on deal quality: strong purchase price, substantial equity, and realistic timelines improve approval odds. Discuss your credit situation directly with potential lenders—some specialize in working with investors with challenged credit.
How is gap funding different from a second lien?
Gap funding and second lien are closely related—gap funding is typically structured AS a second lien. A second lien is the legal position: it means the holder is paid second in the priority of repayment (after the first lien holder). Gap funding emphasizes the financing purpose: bridging a capital gap. So gap funding is often a second lien by structure, but the term "gap funding" focuses on the purpose (filling a gap), while "second lien" focuses on the legal position (paid second). They're generally used interchangeably in the industry.
Can gap funding be used with hard money loans?
Yes, this is one of the most common structures. Hard money lender provides 60-75% of the purchase price as a first lien. Gap lender fills the remaining gap between that and your down payment as a second lien. Example: $300k purchase, $75k down (25%), hard money $225k (75% first lien), gap funding $0. But if down payment is only $50k, gap funding provides $25k second lien. This combination lets you buy with less than 30% down while covering all costs—highly efficient use of capital for experienced flippers.
Does gap funding impact my total profit?
Yes. Interest costs, points, and other fees paid to the gap lender reduce your net profit compared to a scenario where you self-fund. However, the strategic benefit of gap funding is enabling you to do multiple deals simultaneously, improving overall portfolio returns. Example: Using all your cash on one deal yields $80k profit. Using gap funding on 4 deals might yield $240k total profit despite each individual deal netting slightly less. The portfolio-level impact is usually positive for active investors managing multiple projects.
What metrics should I evaluate before using gap capital?
Before committing to gap funding, analyze: (1) Net profit in dollars; (2) Profit margin as % of ARV (target 15%+); (3) Cash-on-cash return % (target 50%+); (4) ROI % (target 30%+); (5) Holding period impact on interest costs; (6) Break-even sale price (if project fails, can you still repay?); (7) Your total portfolio debt level; (8) Opportunity cost of capital (could you deploy less capital on a different deal?). Use our calculator to model different scenarios and identify which funding approach maximizes risk-adjusted returns.
What closing costs should investors expect?
Typical real estate closing costs are 2-5% of purchase price, including title insurance, appraisal, survey, recording fees, and lender origination fees. Gap funding adds additional fees: origination/processing fees (typically 1-3% of gap amount), possibly wire transfer fees, and attorney fees if required. Budget carefully—a $300k purchase with 3% closing costs = $9,000 plus gap fees. These costs reduce your available capital for repairs and contingencies. Factor all closing costs into your pro forma to ensure deals still hit profit targets.
How does holding period impact interest and returns?
Holding period has dramatic impact on profitability. Interest accrues monthly—a 6-month hold at 12% costs 6% total interest, while a 12-month hold costs 12% total interest. Example: $100k gap loan, 6 months at 12% = $6,000 interest. Same loan, 12 months = $12,000 interest. That's an extra $6,000 cost for an additional 6 months. Also, carrying costs (taxes, insurance, maintenance) continue accumulating, further reducing profit. Every month of delay costs you real money—focus on efficient execution and realistic timelines to preserve returns.