Know about gap financing and its Uses: Gap financing is associated with an interim loan offered to an individual or a company to bridge the difference between a committed maximum permanent loan and the least amount of funds a lender is ready to release for a loan (floor loan). Primarily its association is with property or mortgage loans.
Precisely, it covers the gap in negotiations, funding and time. It’s a short-term or a subordinate and temporary loan meant to assist people or companies in catching up their immediate financial obligations, until the time they find a way to suffice their long term needs for funds.
An asset-based Loan
One can define it as a loan based on assets (ABL). It takes place when the existing loan amount or funding amount eclipses the collateral value.
The Situation For Gap Financing
The circumstances normally arise during the floor-ceiling loan of the permanent type. Here, the borrower fails to meet up the roll-rent need. Due to this, the mortgagee provides just the floor amount. The loaner agrees to offer the rest of the funds upon the payment of rent-roll requirement in a stipulated period.
Here, the gap lender is also the construction lender, who agrees to make the gap loan before the construction. The buy-sell agreement is one document that aggregates or binds permanent loan, gap loan or the construction loan all along.
There are sundry regulations in the agreement that state the terms and conditions of the document. There’s an exclusive provision which says that if rent-roll holdback of the permanent lender remains unaccomplished during the permanent closing, the construction lender coheres to disburse money equivalent to the withheld amount by the creditor in accord to its commitment on date of concurrent closing.
The subordinate of permanent loan documentation and an inferior mortgage subject secure the promissory note used as the evidence in the case of gap funds.
Demand To Purchase
In the natural and unambiguous state of affairs, if the rent-roll need is not fulfilled during the time, the permanent lender owns the right on-demand to buy the gap note. Also, it can discharge the record held by a construction lender for a second mortgage.
Help From Bank Representatives
Any customer who has a dire need of gap financing, representatives of banks step in to help them. The officials guide the clients and initiate a discourse on how they can manage to offer suitable loans. The loan provided here is at low risk of default and for short-term.
How Does The Gap Financing Function?
- The loan has to be repaid within six months’ to a year’s time. Hence it’s a loan with a short-duration of repayment.
- It has a higher rate of interest because the lender is on the verge of risk and the arrangement only adds up to it.
- The borrowers of the gap financing have to attach their property as collateral.
Examples of Gap Financing
- The gap financing in home loans emerges between the funds a bank is paying willingly and the overall amount of credit.
- Besides the conventional loan for a home, the creditor can see a specific amount for making a down payment.
- The gap financing can assist in reaching the gap for completing the project. It is the gap between the development cost and the projected sales price.
Here are some steps for calculating gap financing or funding.
- Segregate liabilities into maturity buckets.
- Then find out the RSL(rate sensitive liabilities) and RSA (rate sensitive asset) value from each bucket.
- Thus, the formula for gap financing is:-
Value of RSA – Value of RSL = FGAP
PS:- The gap financing can be materialised for rehab lending as well. It stows the gap between the rehab lender and the borrower’s down payment. Rehab lenders typically pursue the after repair value (ARV) of 65-70%.
Advantages of Gap Financing
- It empowers in scaling up the number of deals at a given time.
- The process spikes the cash-on-cash return on investment (ROI).
- One can make a hefty amount of profit despite bringing less to no cash on the table for a deal.
- It offers relief from the payment of interests.
Words of Wisdom
- Gap financing comes in play primarily during the higher-end deals.
- It offers a fair amount of profit.
- It suffices the financial needs. Hence a party or a person can strike more than one deal.
- Gap financing minimises the amount of cash during a deal.
- However, it is not for every deal.