Factor Rates Explained: How to Calculate What a Merchant Cash Advance Actually Costs

When you're shopping for a merchant cash advance, you won't see an interest rate quoted anywhere. Instead, MCA providers use 'factor rates' — a number between 1.1 and 1.5 that determines your total repayment. This seemingly simple number can obscure the true annualized cost of MCA financing.

Understanding factor rates is essential to knowing what you're actually paying. This guide will teach you how to read factor rates, estimate APR equivalents, and avoid common pricing traps.

What Is a Factor Rate?

A factor rate is a multiplier applied to your advance amount to determine total repayment. Unlike interest rates, which represent a periodic cost of borrowing, a factor rate is a one-time multiplier that sets your total payback amount upfront.

• Factor rate of 1.2: You repay $1.20 for every $1.00 advanced
• Factor rate of 1.3: You repay $1.30 for every $1.00 advanced
• Factor rate of 1.4: You repay $1.40 for every $1.00 advanced
• Factor rate of 1.5: You repay $1.50 for every $1.00 advanced

The calculation is simple multiplication. If you receive $50,000 at a factor rate of 1.25, you'll repay $50,000 x 1.25 = $62,500 total.

Common Factor Rate Ranges

Factor rates typically fall within these ranges, depending on your business risk profile:

Be cautious of factor rates above 1.5. At these levels, you're paying back more than 50% over your advance amount, often in a matter of months.

Estimating APR From Factor Rate: The Basic Math

To understand the annualized cost, you need to estimate an APR equivalent. This requires knowing the repayment term. Here's a simplified approach:

Basic Estimated APR = ((Factor Rate - 1) / Repayment Term in Years) x 100

However, this simple formula understates the true cost because it doesn't account for the fact that you're paying down the principal throughout the term. A more accurate approach:

Adjusted Estimated APR = ((Factor Rate - 1) / (Repayment Term in Years x 0.5)) x 100

The 0.5 factor accounts for your average balance being roughly half the initial advance as you pay it down. Note: This is an estimate — actual APR calculations for disclosure purposes use more complex methods.

Example 1: Lower Factor Rate, Short Term

Let's estimate the APR for a relatively favorable MCA:

Using the adjusted formula: Estimated APR = ((1.15 - 1) / (0.33 x 0.5)) x 100 = approximately 91%

Even with a 'low' factor rate of 1.15, the short 4-month term means you're paying an equivalent of roughly 91% annual interest by this estimate.

Example 2: Mid-Range Factor Rate

A more typical MCA scenario:

Estimated APR = ((1.30 - 1) / (0.5 x 0.5)) x 100 = approximately 120%

This is a common MCA structure. You're paying back $15,000 for six months of capital access, equivalent to roughly 120% annually by this estimate.

Example 3: Higher-Risk Factor Rate

For businesses with credit challenges, factor rates can get higher:

Estimated APR = ((1.45 - 1) / (0.42 x 0.5)) x 100 = approximately 214%

Understanding Holdback Rates

The holdback rate (also called retention or split percentage) determines how much of your daily sales goes toward repayment. Common holdback rates range from 5% to 25% of daily card sales.

Higher holdback rates mean faster repayment but more strain on daily cash flow. The holdback rate also affects your effective APR — faster repayment with the same factor rate means higher APR.

• Lower holdback (5-10%): More manageable daily impact, but longer term.
• Medium holdback (15-20%): Common range that balances cash flow impact with term length.
• High holdback (25%+): Aggressive repayment that can strain operations.

Hidden Fees to Watch For

Factor rates aren't the only cost. MCA agreements often include additional fees:

• Origination fees: Often 1-3% of the advance, deducted from your funding amount.
• Administrative fees: Monthly or one-time processing charges.
• ACH fees: Charges for each bank withdrawal (can add up with daily payments).
• Broker fees: If you used a broker, their commission may be built into your factor rate.
• Prepayment terms: Unlike loans, MCAs often don't reduce the total owed for early payoff. Review the terms carefully.

A Note on Prepayment

With traditional loans, paying off early saves you money because you stop accruing interest. MCAs often work differently. Your total repayment amount may be fixed at signing, regardless of how quickly you pay.

If you take a $50,000 advance at 1.3 factor, you may owe $65,000 whether you pay it off in 3 months or 6 months. Paying faster would actually increase your effective APR because you're paying the same fee for a shorter capital use period.

Some MCA providers do offer prepayment discounts, but these need to be negotiated upfront. Ask specifically about prepayment terms before signing.

Comparing Offers: Total Cost vs. Factor Rate

When comparing MCA offers, don't just look at factor rates. Consider the complete picture:

Offer A has a lower factor rate AND a lower estimated APR due to the longer term. It also has lower daily payments that may be easier to manage. The 'best' offer depends on your cash flow capacity and how long you need the capital.

Key Takeaways

Understanding factor rates is essential to making informed MCA decisions:

• Factor rates between 1.1 and 1.5 represent costs of 10% to 50% of your advance amount.
• Short repayment terms dramatically increase the equivalent APR.
• A 1.3 factor rate over 6 months can equal approximately 120% estimated APR.
• Account for all fees, not just the factor rate, when calculating true cost.
• Prepayment typically doesn't reduce total owed — ask about discount provisions.
• Always estimate APR to compare MCAs against other financing options.

Armed with this knowledge, you can evaluate MCA offers more clearly. In most cases, the calculated APR will confirm that exploring alternatives is worth the effort.