Table of Contents

  • What’s Different Between a Factor Rate vs. an Interest Rate?
  • How to Calculate Factor Rate Costs
  • How to Convert a Factor Rate to an Annualized Interest Rate
  • How to Find a Competitive Rate on a Business Loan
  • Why Consider Factor Rate Financing?
  • Finding the Right Factor Rate Financing

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Understanding factor rates is crucial when you’re trying to calculate costs of certain types of financing. A factor rate is a decimal figure that is multiplied by the total amount financed to calculate the complete cost of borrowing. 

You’ll see factor rates commonly applied to certain types of short-term business financing, such as merchant cash advances and accounts receivable financing. 

Factor rates often start at 1.1 and rise from there. The lower your factor rate, the more affordable the financing. 

What’s Different Between a Factor Rate vs. an Interest Rate?

One of the biggest differences between a factor rate vs. an interest rate is the way your payments are calculated and applied. 

With most loans, when the lender charges interest you can repay early and save money. This isn’t the case with factor rates. A factor rate is calculated only once, at the beginning of the lending period. You’re responsible for the total amount financed and fees calculated by your factor rate no matter what. Paying off your funding early won’t lower your total repayment. 

In contrast, for interest rate loans, the interest amount applied to your balance adjusts throughout the life of a loan. Interest amounts can change based on the payment schedule and the frequency (or lateness) of the payments. For instance, if you pay off your interest rate loan early, you’ll save in interest over the life of the loan. 

Because factor rate financing is used most often with short-term funding options, most lenders require you to make daily or weekly payments instead of monthly factor rate repayments. 

Interest Rate vs. Annual Percentage Rate

Keep in mind, an interest rate isn’t the same as an annual percentage rate (APR). Interest rate refers to the cost of borrowing your loan’s principal. Your installment payment is based on your interest rate. 

 

An APR, on the other hand, affects your total loan repayment and takes your interest rate into account as well as other lender costs, such as origination fees. Your APR will tell you the total annual cost for taking out a business loan.

How to Calculate Factor Rate Costs

Want to know how to calculate factor rates and what the numbers mean? 

Here’s the factor rate cost repayment formula:

Total Amount Financed x Factor Rate = Repayment Amount

Additionally, funding fees are common of factor rate financing and separate from the factor fee.

An Example

Let’s say you’re applying for merchant cash advance financing in the amount of $20,000. The lender quotes you a merchant cash advance factor rate of 1.2. 

 

Simply multiply your factor rate of 1.2 by your total amount of financing, in this case, $20,000.

 

1.2 x $20,000 = $24,000

 

The amount that exceeds your advance amount is your cost to borrow the funds. In this case, to get a $20,000 advance, you’ll pay $4,000. 

 

In other words, you’ll repay $24,000 — your advance amount plus your merchant cash advance factor fee amount. 

You also can calculate the factor rate from your total repayment amount. To do so, you’d take your total repayment amount and divide it by the financed amount. 

For instance, using our example, we’d divide $24,000 by $20,000. This would give us a factor rate of 1.2.

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Use a Calculator to See Factor Rate Payment Installments

Online financing calculators can help you determine your factor rate payment, whether you have a daily, weekly or monthly factor rate. 

Use an online merchant cash advance calculator to estimate your payment schedule. Gather the following information for your results:

  • Financing amount
  • Factor rate
  • Repayment term

For example, we can use an online merchant cash advance calculator to see how much our previous example would cost on a daily or weekly basis. Specifically, financing of $20,000 at a 1.2 factor rate over a term of 6 months would equate to estimated payments of $190 a day, based on 126 payments. Alternatively, the same factor rate financing set up to be paid weekly would cost an estimated $952 per week, based on 25 payments.

How to Convert a Factor Rate to an Annualized Interest Rate

Factor rate financing doesn’t typically extend to a year, so calculating an annual fee isn’t really a way to compare apples to apples. That being said, if you’d like to see what your factor rate would equate to in terms of annual interest, here are the steps you’ll need to take.

Taking our example above, with a $20,000 merchant cash advance at a 1.2 factor rate, you’d pay a total of $24,000, or $4,000 in financing. 

Take the original advance amount ($20,000) and divide it by the financing costs: in other words, $4,000 ÷ $20,000, which equals 20%. 

We’d then take that percentage rate (20%) and multiply it by the total number of days in a year, 365. This would give us 73.

Finally, take that number and divide it into the total repayment period.

Let’s say our merchant cash advance is due in 6 months. We’ll assume 30 days a month, or 180 days. In other words, 73 divided by 180 would give us an estimated annual interest rate of 40.6%.

How to Find a Competitive Rate on a Business Loan

Shopping around and comparing loan offers will help you find the right factor rate or interest rate for your business. Because your rate may vary based on a variety of different factors, it makes sense to consider alternatives and learn more about what impacts your rate.

What Impacts Your Factor Rate?

Your factor rate can vary from one lender to another depending on your business health and credit history, though many factor rates fall between 1.1 and 1.5 range. That being said, no two businesses or applicants receive the exact same rates and offers. 

Business financing can be complex and lenders must be certain their risk is as low as possible. So they’ll make a strong effort to evaluate your business model and look for a solid history of strong cash flow and payment of any obligations and debts.

When you present your application, you’ll probably be asked for additional documentation to help the lender see how well your business is doing. And depending on the lender’s expectations, you could be offered a higher or lower factor rate.

Lenders look at a number of factors that can impact your factor rate, such as:

  • Bank statements: Your business bank statements are one way you can demonstrate cash flow to your lender so they can evaluate creditworthiness and see how strong your business is. Usually, they’ll ask for at least 3 months of data, but they may need more.
  • Credit-card processing statements: Another way to show your business is selling products or services and that you’re taking in income.
  • Length of time in business: Generally, the older your business is, the more established and credit-worthy it is to lenders. Brand-new businesses may not be eligible for a cash advance or short-term loan right away.
  • Business tax returns: Consistent, stable income reports on your business taxes are another form of cash flow proof that a bank or alternative lender may ask for when you apply.

Keep in mind determining the factor rate depends on the lender. Banks and alternative lenders have their own approaches to evaluating applications. Once you learn what your factor rate is, you’ll be able to compare the full borrowing cost with other offers you receive.

What Is the Interest Rate on a Business Loan?

Unlike factor rates, loan interest rates are expressed as percentages, not decimal figures. (For instance, 10%.)

Some of the best small business loan rates may range from 3%-10%. Other loans may have interest rates in the high double digits. 

If you’re wondering what is the interest rate on a business loan from a particular lender, consider that interest rates business lenders quote depend on a variety of factors, which could include the following:

  • Loan amount
  • Collateral 
  • Business or personal credit score
  • Annual business revenue
  • Length of time in business

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Why Consider Factor Rate Financing?

You might be wondering why you’d consider factor rate vs. interest rate financing. Funding products with factor rate terms often appeal to business owners with low credit scores who are looking for fast access to cash. Many times, online lenders are able to fund you the same day you apply. 

Remember, factor rate financing is typically seen with short-term financing, such as accounts receivable financing and merchant cash advances. In most of these cases, there are no restrictions on how you can use your funds. 

You might consider factor rate financing to get money for the following: 

  • Payroll
  • Rent
  • Utilities
  • Taxes
  • Emergencies
  • Repairs
  • Equipment purchases
  • Working capital

Finding the Right Factor Rate Financing

For your business, the right factor rate financing likely depends on a variety of factors. Repayment options, borrowing terms and impact on personal credit may be aspects of business borrowing that you’re thinking about as you weigh your options.

Calculating your cost of borrowing tells you upfront how good of a deal you’re getting on your loan, allows you to make easier comparisons and helps with planning. As you consider your business borrowing options, you may find multiple offers and be in a position to compare different factor rates. 

Whatever you do, it’s crucial to do your own research into business lending. Find the information, advice and practical help you need to make borrowing part of your business success story. Don’t hesitate to ask questions and get specific pricing, special offers and terms when you shop around for factor rate quotes. 

It’s your business. Find the best business financing that suits your goals.

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