Hard Money Covers 90%. Who Covers the Rest? Pricing Gap Funding and Private Money Splits Into Your Flip MAO

The Cash Gap Nobody Puts in the Deal Sheet

The term sheet says 90% of purchase and 100% of rehab, and it is easy to read that as "almost no money down." Then closing week arrives and the title company sends wire instructions for a number you did not budget. Hard money finances the house and the renovation. It does not finance the cost of owning the loan.

Take a $200,000 purchase with a $70,000 rehab. The lender funds $180,000 at closing plus $70,000 in draws, for a $250,000 loan at 11% interest-only with 2 points. Here is what still comes out of someone's pocket:

• Down payment: 10% of $200,000 = $20,000
• Buyer closing costs: about $4,000
• Points: 2% of $250,000 = $5,000, due at closing
• Interest: roughly $215,000 average drawn balance x 11% / 12 = $1,971 per month, or $9,855 over five months
• Carrying costs (taxes, insurance, utilities): $600 per month, or $3,000

That adds up to $41,855 before the property is listed. For most investors that check gets split across several sources, and together those sources make up the capital stack. The stack usually has four layers: the senior hard money loan in first position, a gap or second-position note that covers part of the shortfall, an equity partner who puts in cash for a share of profit, and your own cash at the bottom.

Start with the standard formula: MAO = (ARV x 0.70) - repairs. At a $390,000 ARV, that is $273,000 - $70,000 = $203,000, so the $200,000 purchase looks like it fits. The 30% cushion is supposed to absorb selling costs, holding costs, financing, and your profit. It quietly assumes that financing means one senior loan at a known rate.

Every layer above your own cash has a price. A gap note might charge 12% plus 2 points, and a partner might take half the profit. None of those costs show up in the 70% rule, so each one has to be priced and subtracted on top of it. If you skip that step, a deal that clears the MAO on paper can lose a third of its profit once the people funding the gap get paid.

Worked Example: Sizing the Gap on a $320K ARV Flip

Take a three-bed ranch with an ARV of $320,000, a contract price of $180,000, a $55,000 rehab, and a six-month hold. Your hard money lender funds 90% of the purchase ($162,000) plus 100% of the rehab ($55,000). That adds up to a $217,000 loan at 11% interest and 2 points. On paper it looks like the lender is carrying the deal, but the term sheet hides how much cash still has to come from you.

Start with the lender's own charges. Points are $217,000 x 0.02 = $4,340, due at closing. Interest is $217,000 x 0.11 / 12 x 6 = $11,935, paid monthly from your pocket. That assumes the full balance is outstanding from day one. If rehab funds come in draws, actual interest runs a little lower, but budgeting the full figure protects you if the timeline stretches.

Now tally every dollar the loan does not cover. Each of these leaves your account before the house sells:

• Down payment (10% of purchase): $18,000
• Buyer closing costs (3%): $5,400
• Points: $4,340
• Interest over 6 months: $11,935
• Taxes, insurance, utilities ($600/mo x 6): $3,600

The total is $43,275, or roughly $43,300. That is your gap, and it equals about 20% of the loan amount on a deal many new flippers would call "90% financed."

Next, check whether the deal can afford to pay for that gap. Here is profit before any gap financing cost, line by line:

• $320,000 ARV - $180,000 purchase = $140,000
• $140,000 - $55,000 rehab = $85,000
• $85,000 - $5,400 closing = $79,600
• $79,600 - $4,340 points = $75,260
• $75,260 - $11,935 interest = $63,325
• $63,325 - $3,600 holding = $59,725
• $59,725 - $25,600 selling (8%) = $34,125

You have $34,125 of profit to share between yourself and whoever fronts that $43,300. If a gap lender charges 12% plus points, or a partner wants half the upside, that number shrinks fast. Knowing both figures before you write an offer is what lets you price the gap instead of discovering it at closing.

Worked Example: Gap Note vs. 50/50 Equity Partner, and What Each Does to Your MAO

Same deal, same $45,000 gap, two ways to fill it. Before any gap funding cost, this flip projects $34,125 in profit after rehab, buying, holding, and selling costs. The question is how much of that $34,125 each money source takes, because whatever they take comes straight out of your pocket.

Option 1: a gap note at 12% plus 2 points for 6 months. Interest runs $45,000 x 12% x 0.5 years = $2,700. Points add $45,000 x 2% = $900, for a total cost of $3,600. Subtract that from $34,125 and you keep $30,525. The lender's cost is fixed, so it doesn't grow if the flip outperforms.

Option 2: a 50/50 equity partner. Your partner funds the $45,000 and splits the $34,125 profit evenly. That hands over $17,062 and leaves you about $17,063. You paid $13,462 more for the same $45,000 than you would have with the note. Equity only wins when the deal goes badly. Since the note costs a flat $3,600, the split beats it only if total profit falls below $7,200 (because half of $7,200 is $3,600). On a deal projecting $34,125, you're paying a large premium for downside insurance.

Now flip the math around and ask what purchase price still hits a $30,000 profit target under each structure. This is where the funding choice moves your MAO. To keep the comparison clean, hold rehab and the gap size roughly constant.

• Gap note: You clear $30,525, so you have about $525 of cushion. Your MAO sits roughly $525 above the price used in the previous section.
• 50/50 split: Your half must equal $30,000, so the deal must produce $60,000 total. That's $25,875 more than $34,125, which means you need to buy about $25,875 cheaper.

That puts roughly $26,400 between the two MAOs on the same house. If you plan to bring in an equity partner, decide that before you write the offer, not after it's accepted.

Edge Cases: When Equity Splits, Seller Credits, and Timeline Slips Change the Answer

A 50/50 equity partner looks expensive next to a gap note, but the comparison changes when the deal is thin or the ARV is shaky. A gap lender gets paid whether you profit or not. An equity partner who shares downside risk absorbs half of any loss, so giving up half the upside can be cheap insurance on a deal with uncertain comps or a big unknown behind the drywall.

Gap funding has its own catch: many senior lenders require written consent for any second lien, and some prohibit secondary financing outright. Ask your hard money lender before you sign a gap term sheet, not at the closing table. Seller credits can shrink your cash to close, but most lenders cap them (often as a percentage of the purchase price) and may treat anything above the cap as a price reduction instead.

Timeline slips hit stacked debt harder than single-source deals. On this example, a 3-month delay adds about $5,970 in senior interest, $1,800 in carrying costs, and $1,350 in gap interest, for $9,120 total. That comes straight out of your profit, so a slip can cut a $30,000 margin by nearly a third before you sell.

Preferred returns also cost differently than straight splits. Say a partner puts in $40,000 at an 8% annual pref, then 50/50. Over 6 months the pref is $1,600. On a $30,000 profit, the partner takes $1,600 plus $14,200 ($15,800 total) versus $15,000 on a straight split. On a $10,000 profit, they take $5,800 and you keep $4,200, so the pref bites hardest when margins shrink.

Use this quick rule when choosing a structure:

• Gap note: fat margin, solid comps, short timeline, and a senior lender that allows it.
• Straight equity split: thin or uncertain deal where shared downside matters more than upside.
• Pref then split: confident margin, partner wants priority, and you can absorb a slip.

Common Mistakes When Stacking Money on a Flip

Stacking a hard money loan, a gap note, and a partner's equity can get you into a deal with very little of your own cash. It can also bury your profit under costs you never wrote down. Most of the damage comes from a handful of repeat errors, and each one is easy to catch once you know where to look.

• Modeling only the senior loan. The gap note carries its own rate, points, and sometimes a profit kicker. Leave it out and your margin looks fatter than it really is.
• Forgetting that monthly interest comes from your pocket. On a $240,000 hard money balance at 11%, interest-only payments run $2,200 a month. Over a 6-month hold, that is $13,200 in cash you must have before the sale closes.
• Pricing a split on projected profit. Giving a partner 50% of a projected $60,000 sounds like $30,000 each. Stress-test it with a lower ARV and two extra months, and profit might land near $40,000, so each side really gets $20,000.
• Double counting points. If gap money pays the hard money lender's points, those points already sit inside the gap balance. Listing them again as a separate closing cost distorts every number downstream.
• Ignoring extension fees. Many hard money loans charge 1 point to extend. On $240,000, that is $2,400, often triggered by one permit delay.
• Offering at a 70% rule MAO that assumed all cash. The rule bakes in typical costs, not two layers of financing. Stacked money usually means a lower offer.

The common thread is mixing deal math and financing math into one messy spreadsheet. When the ARV, rehab, and holding costs are fuzzy, every financing layer you add on top inherits that fuzziness. You end up negotiating a split with a partner using numbers neither of you fully trusts.

A cleaner approach is to lock the base deal first. Running the address through FlipSmrt gives you an ARV from adjusted sold comps within 0.5 miles, line-item rehab by trade priced for the county, holding costs, and an MAO in under 5 minutes. With that base number set, you can layer gap interest, split terms, and extension risk on top and see exactly how far your offer needs to drop before you call a partner.

FAQ: Gap Funding and Private Money Splits

Is gap funding legal with a hard money first? Generally yes, but many hard money lenders prohibit second liens or require disclosure of every other source of funds. Hiding a gap note can put your first loan in default, so get the first lender's written approval before closing. If your gap partner takes equity instead of a note, ask an attorney whether securities rules apply in your state.

Should a private lender's return count as a holding cost or a profit share? It depends on the structure. A fixed-rate note (say 12% plus 2 points) is a financing cost, so it belongs in your holding and buying costs and lowers your MAO directly. An equity split comes out of profit after the sale, so leave it out of costs and size your target profit high enough to cover both partners. Counting the same money in both places is a common way to talk yourself out of a good deal.

How much skin in the game do most hard money lenders expect? Many want the borrower to cover 10% to 20% of the purchase price, plus closing costs and sometimes the first rehab draw. Terms vary widely by lender, experience level, and loan-to-ARV caps, so get a term sheet early. Your cash requirement is a line item, not a guess.

Is using your own cash really free? No, because that money could be earning a return somewhere else. If you put $40,000 into a six-month flip and could have earned 8% elsewhere, the opportunity cost is $40,000 x 0.08 x 0.5 = $1,600. It won't appear on a settlement statement, but it should appear in your decision.

How should I present the deal to a private partner using a FlipSmrt analysis? Share the full report: the adjusted sold comps behind the ARV, the line-item rehab by trade, the MAO, and the go or no-go verdict in plain English. Then show exactly where their dollars sit in the capital stack and how and when they get repaid. A partner who can check your comps and rehab budget line by line will trust your numbers faster than one handed a single profit figure.