What Is a Factor Rate?

A factor rate is the pricing method most merchant cash advance offers use instead of an interest rate. It is a single decimal number, usually between 1.1 and 1.5, that tells you the total amount you will pay back relative to the amount you receive. It is simple to read, but it hides how expensive the advance really is on an annual basis.

How a factor rate works

The calculation is multiplication. If you receive $40,000 and the factor rate is 1.35, your total payback is $40,000 multiplied by 1.35, which equals $54,000. The cost of the advance is the difference, $14,000. Unlike an interest rate, the factor rate does not reduce as you pay down the balance. The cost is fixed at the start and does not change with the repayment schedule.

Why the factor rate is not an interest rate

An interest rate is expressed as a yearly percentage, so you can compare a 12% loan to a 20% loan directly. A factor rate is a multiplier with no time component, so a 1.35 factor rate means something very different if you repay it over three months versus twelve months. The same total cost is far more expensive when it is collected quickly, because you are paying the same dollar amount in a much shorter window.

How to estimate the annualized cost

To compare a factor-rate advance to a loan, estimate the annualized cost. First find the total cost by subtracting the funding amount from the total payback. Then divide the cost by the funding amount to get the cost as a fraction of what you received. Finally, scale that fraction to a full year based on the repayment term. A 1.35 factor rate repaid over six months works out to a far higher annual percentage rate than the same factor rate repaid over twelve months.

What to check before you accept

Always confirm the funding amount you will actually receive after any fees, the total payback amount, the number of payments, and the payment schedule. Ask whether fees are included in the payback figure or added on top. These four numbers let you estimate the annualized cost and compare the offer to other financing on equal terms.