The interest lenders charge on some types of loans is called a factor rate-sometimes referred to as a money factor. A factor rate is not to be confused with interest rates or an APR (annual percentage rate). In this article, we discuss what you need to know about factor rates affect and how they affect financing your business.
How Do Factor Rates Work?
Factor Rates vs. APR Interest & Rates
Factor rates only apply to the original loan amount. Interest rates compound and change as you decrease the debt.
The Annual Percentage Rate (APR) on a loan includes other fees and payments not related to the factor rate.
Understanding How Factor Rates Affect Your Business
You need to get a grasp on how a factor rate affects the real cost of your loan.
Several business aspects can affect your rate factor, such as:
- the amount of the loan
- your business’s credit history
- how long you’ve been in business
First, calculate the total amount you will need to pay back. Here’s how:
- Multiply the factor rate by the amount borrowed
- $10,000, factor rate of 1.35, 12-month term
- Total you will repay is $13,500 ($10,000 x 1.35 = $13,500).
- At first glance, you see that you will be paying $3,500 for a $10,000 loan over a year
- And it looks like you are being charged a 35% interest rate
However, that is not entirely the correct way to look at it.
The interest cost on the loan is 35%, but when a factor rate is used, all the interest is added on the front-end of the loan. That’s the key difference.
When a loan is calculated using APR, interest accrues on the principal amount and compounds as more payments are made.
How Factor Rates Impact Merchant Credit Card Sales
How much you will be charged for your merchant credit card sales depends on:
(a) how often you submit your credit card sales (daily, weekly, etc.) and
(b) how strong a sales day you’ve had; the higher your sales, the more you will pay
Merchant sales funding is one of the most costly financing products on the market.
Your Merchant Account
What does a merchant financing company consider when determining the factor rate?
- Accounts receivable and accounts payable aging
- Annual business revenue and profit
- Balance sheet
- Bank statements
- Business credit score
- Business licenses and permits
- Business plan
- Copy of your commercial lease
- Desired loan amount
- Disclosure of other debt
- EIN
- Entity type
- Industry
- Legal contracts and agreements
- Loan purpose
- Ownership and affiliations
- Personal and business tax returns
- Personal credit score
- Proof of collateral
- Time in business
Any time you are entering into any type of financing contract for your small business, and you don’t understand the terms or language in the agreement, don’t be afraid to ask questions. A suitable lender will be more than eager to explain anything you don’t understand.
The Bottom Line
Understand the difference between a factor rate, interest rate, interest cost, and an APR. By understanding how factor rates work and how much that financing will be costing your business, you will be able to make a more informed decision.
Next Steps
If you are looking to seize an opportunity for your company and get cash quickly, contact the Ridgestone Capital team today! We can answer your questions and put your mind at ease with the funds you need to get the most out of your business.
Whether you are looking for start-up capital, capital for inventory or new equipment, to secure a funding safety net, or looking to expand/scale your enterprise, Ridgestone Capital has the right financing solution for your business! Give us a call today!
