Question

Third-party lenders sometimes provide gap financing for project developments. Why is this lending used? How does it work?

Answer 1

Gap financing is the the term given to the second lending where in a private lender funds a project on which the borrower has already taken loan but the first lender has not provided full amount reequired for that project. So the borrower shall approach a third party lender to borrow the remaining portion of the project's fund requirement.

Example: A requires $10,000,000 for his project. He approaches XYZ bank for the loan but XYZ bank finance only 75% of the project so A approaches B for the remaining $2500000 B lent $250000 to A on the second lien on the Project.

Onother varient of the above example may be that A requires 7500000 immediately for initial capital expenditure and remaning 2500000 after one year for expansion but the XYZ bank puts a restriction that it will provide 2500000 only if the project starts generating revenue equal to or more than $1000000. But A wants to be sure as to whether he will get money on expansion or not so He approaches B and contracted with him to receive 2500000 whether or not project generates any revenue. Now if after two years the condition imposed by XYZ bank is fulfilled the bank shall provide 2500000 to B if A has instructed it to do so.

GAP financing is extremly risky for the lender because he has only second mortgage on the project and if the project dose not perform well second lender's all money at risk.

Why investors end up investing in second lending?

Firstly borrowers are ready to pay higher interest on smaller amount because they are in need.

Secondly lenders may not have enough money to finance full money required for a project so they may lend as a Junior lendor.

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