Bridge Loan VS Gap Loan: What You Didn’t Know
Although both of these loan types fall in the same category of hard money loans, these are two different types of loans.
When referring to bridge loans, the term “bridge” describes this type of loan because this type of loan serves to “bridge” the borrower to another future outcome.
- A bridge loan is a loan in a senior, or first lien position, and serves as the primary financing vehicle for the borrower.
In contrast, a gap loan serves as a secondary financing vehicle for a borrower, and is a loan in a junior lien position.
- A gap loan can be subordinate to a bridge loan in a first position.
- Similar to mezzanine debt, a gap loan is so-called because it “gaps” the difference between the borrower’s primary loan and the borrower’s available cash on hand.
Let me explain further using the 3 examples below.
Example 1: A bridge loan is used to buy an investment property fast.
Once the investor acquires the property, they would then get a traditional bank loan to replace the bridge loan.
In this example, the bridge loan served to “bridge” the borrower from the acquisition to another form of financing.
Example 2: A real estate investor already owns an income-producing property.
The bank loan on the property is coming due, and the borrower seeks to refinance the loan with another bank loan.
But, the borrower’s credit score is hit hard due to a recent divorce, and no bank will refinance the loan because of the borrower’s low credit score.
The borrower is able to get a bridge loan in place for a term of 12 months while in credit repair. Once the credit score gets above 700, the borrower is able to qualify for a bank loan and pays off the bridge loan.
Example 3: A real estate investor purchases an income-producing property. This property is currently vacant and in need of significant repairs.
Such a property would not qualify for traditional bank financing. The investor obtains the bulk of the financing in the form of a bridge loan to purchase the property.
Because significant repairs are required, the investor is short on cash to repair the property.
The investor obtains a gap loan, in a second lien position behind the bridge loan, and uses the funds from the gap loan to repair the property.
Once the necessary repairs are completed, the borrower then leases out the property. The borrower then sells the property to another real estate investor who wants to hold it for the long term.
In this example, the borrower used the bridge loan as the primary financing vehicle to purchase the property. The borrower also used the funds from the gap loan to make the repairs to the property. The bridge loan and the gap loan are both paid off upon sale of the property.
Both bridge loans and gap loans have their unique place in real estate financing. Although both of these types of loans are categorized as hard money loans, they serve very different purposes.