What is a Factor Rate?
Understanding factor rates used in merchant cash advances and short-term business loans, including how to convert them to APR for accurate comparison.
A factor rate is a multiplier used to calculate the total repayment amount on merchant cash advances and some short-term business loans. Unlike interest rates that compound over time, a factor rate is applied once to determine your fixed payback amount.
How Factor Rates Work
Factor rates are expressed as a decimal, typically ranging from 1.1 to 1.5. To calculate your total repayment, multiply the amount you receive by the factor rate.
Example Calculation
If you receive $50,000 with a factor rate of 1.3, you will repay $65,000 total ($50,000 x 1.3 = $65,000). The cost of borrowing is $15,000.
Why Factor Rates Can Be Misleading
Factor rates look simple, but they can obscure the true cost of financing. A factor rate of 1.2 might seem like 20% interest, but because you repay over months rather than a full year, the actual APR is much higher.
For example, a $50,000 advance with a 1.2 factor rate repaid over 6 months has a 20% cost ($10,000). But annualized, that equates to roughly 40% APR or higher, depending on the exact repayment schedule.
Converting Factor Rate to APR
To compare factor rate products to traditional loans, convert to APR:
- Calculate total cost: (Factor Rate - 1) x Loan Amount
- Determine daily cost: Total Cost / Number of Repayment Days
- Annualize: Daily Cost x 365 / Loan Amount x 100
This rough calculation helps you understand that a 1.25 factor rate repaid over 4 months can exceed 75% APR when annualized.
The Prepayment Problem
Unlike interest-based loans where early payoff reduces total interest, factor rate financing typically requires paying the full predetermined amount regardless of how quickly you repay. If you pay off a 6-month advance in 3 months, you still owe the same total, effectively doubling your APR.
Some lenders offer prepayment discounts, but they are not universal. Always ask about early payoff terms before accepting factor rate financing.
When Factor Rates Make Sense
Factor rate products can serve businesses that need fast capital and have high-margin revenue to support the cost. But always calculate the APR equivalent before committing.
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Not Financial Advice: The information provided in this article is for general informational purposes only and does not constitute financial, legal, or professional advice. You should consult with qualified professionals before making any financial decisions.
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Rate Information: Rates, terms, and fees mentioned in this article are estimates based on publicly available information and may not reflect current market conditions or specific lender offers. Actual rates depend on creditworthiness, business financials, and lender policies.
Information May Change: Financial markets, lending regulations, and economic conditions are subject to rapid change. While we strive to keep our content accurate and up-to-date, information in this article may become outdated. Always verify current rates, terms, program availability, and regulatory requirements with lenders and official sources before making financial decisions.