I asked hard money lender Beau Eckstein if he uses gap lending to fund construction loan projects. Here's his answer.
On ground-up construction projects, there is an acquisition of real property (i.e., land) but construction plans have not yet been approved. Often, house flippers don't have the funds necessary to both acquire the land and fund the rehab, or construction, of the property.
So he has to borrow money to fund the acquisition. Oft times this comes in the form of a gap loan.
Then, once the construction plans have been approved, the borrower then gets a more common hard money construction loan that funds all construction during the build. Once the property is fully finished, it gets put up for sale and portions of the sales proceeds is returned to the lenders, with interest of course.
In these cases, with gap lending, the lenders often take a piece of the profits, once the property is sold.