What Is a Factor Rate and How Do You Calculate It?
Factor rates are often used for merchant cash advances and short-term loans. Here’s how to convert them into interest rates to better understand the cost of financing.
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Key takeaways
A factor rate is used to determine how much a loan will cost you. It’s commonly used in alternative forms of financing.
Factor rates are expressed as decimals, in contrast to an annual percentage rate (APR) which is displayed as a percentage.
You can convert factor rates into APRs to compare financing options and get a better sense of the cost of a loan.
Business financing that uses factor rates tends to be very expensive.
What is a factor rate?
A factor rate represents the cost of a small-business loan. They’re expressed as a decimal, unlike interest rates, which are shown as percentages. Online lenders commonly use factor rates to show the price of merchant cash advances and short-term loans.
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How do factor rates work?
Factor rates typically range from 1.1 to 1.5. You multiply a factor rate by the amount you borrowed to calculate the total you’ll pay back to the lender.
A factor rate applies to only the original loan or advance amount. In contrast, an interest rate continues to apply to your remaining balance even as you make payments.
Factor rates are also fixed. They’re set when you borrow the money and don’t change as you pay off your debt (unlike variable interest rates).
Factor rates vs. interest rates
Factor rates | Interest rates |
Expressed as decimals (e.g., 1.2, 1.5). | Expressed as percentages (e.g., 10%, 25%). |
Apply to only the original amount borrowed. | Apply to the remaining balance and compound over time. |
Fixed and don’t change during repayment. | Can be fixed or variable. |
Common with merchant cash advances and short-term loans. | Used for a variety of business and personal financing, including business loans, lines of credit, equipment financing and more. |
How to calculate a factor rate
You can use your factor rate to calculate the total amount of financing you’ll owe to the lender as well as the total cost of your loan or advance.
To calculate the total amount owed, you’ll multiply the funding amount by the factor rate:
Funding amount x factor rate = Total amount owed.
For example, say you receive an advance of $50,000 with a factor rate of 1.4. You anticipate repaying it over six months. Your total repayment amount would be $70,000 ($50,000 x 1.4).
To calculate the total cost of your financing, subtract the original advance amount from the total repayment amount: $70,000 - $50,000 = $20,000.
In this example, that $50,000 advance would cost you $20,000.
How to convert a factor rate to an interest rate
To better understand the cost of a loan or merchant cash advance that uses a factor rate, you should always convert the factor rate into an annualized interest rate. The interest rate won’t include additional fees like an APR does, but it would help you compare the cost of a loan or cash advance with other loans.
Using the same $50,000 advance example, follow the steps below to convert a factor rate into an interest rate.
Step | Equation | Example |
1. Calculate the total amount owed. | Funding amount x factor rate = Total amount owed. | $50,000 x 1.4 = $70,000. |
2. Calculate the total cost of the financing. | Total amount owed - funding amount = Cost of financing. | $70,000 - $50,000 = $20,000. |
3. Calculate the percentage cost. | Cost of financing/funding amount = Percentage cost. | $20,000/$50,000 = 0.4. |
4. Calculate the annual interest rate. |
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Annualized interest rate: 0.802 or 80.2% |
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How lenders determine your factor rate
Lenders typically use the following criteria when setting your factor rate. The better your qualifications, the better your factor rate.
Industry. Some industries are perceived as risky, which could lead to a higher factor rate. Running a seasonal business, for example, can raise concerns over your ability to repay borrowed cash in the off season.
Years in business. The longer you’ve been operating, the more experience and reliability you have as a business owner. This generally means you’ll get a lower factor rate.
Personal credit history. A strong credit score shows your ability to manage your personal finances and pay off debts. The better your credit score, the better the factor rate you’ll receive.
Business financials. If you can show a lender stable cash flow, continued growth and money in your business bank account, you'll help prove that you can afford to take on debt and will be able to repay what you borrow. When you have strong finances, you can access more competitive factor rates.
Debit and credit card sales. These sales are particularly important for merchant cash advance companies because MCAs are repaid as a percentage of those sales. Your current and past sales will illustrate your ability to repay your advance. Higher sales should help you get a lower rate.
