Definition
Gap financing is a short-term loan used to cover temporary funding shortfalls in real estate transactions or development projects. It is commonly used when a borrower needs immediate capital but is waiting for permanent financing or the proceeds from a property sale.
Explanation
Gap financing is often used by real estate investors, developers, and homebuyers to bridge financial gaps in situations such as:
- Delayed Mortgage Approval – A homebuyer needs funds to secure a new home while waiting for their long-term mortgage to close.
- Fix-and-Flip Investments – Investors use gap loans to purchase and renovate properties before reselling them.
- Construction Financing – Developers use gap loans to continue building while awaiting permanent construction loans or investor funding.
- Bridge Loans – Homeowners use gap financing (bridge loans) when they buy a new home before selling their current home.
Gap loans typically have:
- Higher interest rates due to their short-term nature.
- Short repayment periods (a few months to a year).
- Collateral requirements, often secured by real estate.
Example
An investor wants to buy a $400,000 property to renovate and flip but only has $250,000 in available cash. They secure a gap loan for $150,000 to cover the remaining cost. After completing renovations and selling the home for $550,000, they repay the loan and pocket the profit.