Definition
A factor rate is a financing cost metric commonly used in alternative lending products such as merchant cash advances, invoice factoring, and short-term business loans. Unlike traditional interest rates, which are usually expressed as annual percentages, a factor rate is a fixed multiplier (e.g., 1.25) applied to the original loan amount to calculate the total repayment obligation.
How Factor Rates Work
A factor rate represents a predetermined cost of borrowing and does not change over time. It is typically expressed as a decimal—such as 1.20 or 1.45—where:
Repayment Amount = Loan Amount × Factor Rate
For example, a $10,000 loan with a factor rate of 1.25 results in a total repayment of $12,500. Regardless of how quickly the loan is repaid, the borrower owes $2,500 in fees or borrowing costs.
This approach contrasts with interest-based lending, where costs accrue over time, and early repayment can reduce the total price. In factor rate financing, the full repayment amount remains fixed, offering transparency but limiting prepayment benefits.
Use in Business Financing
Factor rates are primarily found in:
- Merchant Cash Advances (MCAs)
Funds are advanced against future receivables and repaid via a portion of daily or weekly sales.
- Invoice Factoring
Lenders purchase unpaid invoices at a discount, collecting full payment from customers later.
- Short-Term Business Loans
Fixed-fee loans repaid daily or weekly over short periods, typically 3–18 months.
Factor Rate vs. Interest Rate vs. APR
| Metric | Description |
| Factor Rate | Fixed multiplier determining total repayment. No compounding. |
| Interest Rate | Percentage charged on the outstanding balance over time. Accrues daily or monthly. |
| APR (Annual Percentage Rate) | Comprehensive cost including interest and fees, annualized for comparison purposes. |
Unlike APR or interest rate loans, factor rate products do not reward early repayment—the borrower is responsible for the full agreed-upon amount.
How to Calculate Cost with a Factor Rate
Step 1: Multiply the loan amount by the factor rate
- $25,000 × 1.25 = $31,250 (total repayment)
Step 2: Subtract the original loan to find the cost
- $31,250 – $25,000 = $6,250 (cost of capital)
Optional Step: Estimate the implied APR
- Total Cost ÷ Loan Amount = 0.25
- 0.25 × 365 ÷ Loan Term in Days
- E.g., 0.25 × 365 ÷ 120 = 76.04% APR
This calculation provides context when comparing with interest-based products.
Determinants of a Factor Rate
Lenders assess several factors when assigning a factor rate:
- Credit Profile: Personal and business credit history
- Cash Flow: Consistency and volume of deposits
- Industry Risk: Sector-specific volatility
- Time in Business: Longevity adds credibility
- Sales Volume: Especially important for MCAs
- Financial Documentation: Tax returns, bank statements, etc.
Factor rates typically range from 1.10 to 1.50, depending on the applicant’s risk profile.
Advantages of Factor Rate Financing
- Fast approval: Common in high-risk or time-sensitive scenarios
- Transparent cost: Total repayment known upfront
- Flexible eligibility: Available to businesses with lower credit scores or limited history
Drawbacks of Factor Rate Financing
- Higher cost: Can result in effective APRs above traditional financing
- No prepayment savings: Full repayment is required regardless of term length
- Tighter repayment schedules: Daily or weekly payments can strain cash flow
Expense Comparison Example
| Loan Type | Loan Amount | Cost | Early Repayment Savings |
| Traditional Loan (10% APR) | $25,000 | ~$1,200 (in interest) | Yes |
| Factor Rate (1.25) | $25,000 | $6,250 | No |
When Are Factor Rates Used?
Factor rates are best suited for:
- Businesses needing quick, short-term financing
- Borrowers who may not qualify for traditional loans
- Firms with strong daily revenue streams, such as restaurants or retail stores
A factor rate offers a straightforward way to calculate the total repayment on a loan, especially in alternative or non-traditional lending scenarios. However, while easy to understand, factor rate financing often comes with higher costs and less flexibility than interest-based loans.
Understanding how factor rates compare to interest rates and APRs is essential when evaluating financing options. Business owners should request full cost disclosures—including APR equivalents and repayment terms—to make informed decisions and assess long-term affordability.
