Draft:Factor rate
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In finance, a factor rate is a decimal figure used to calculate the total cost of a merchant cash advance (MCA) or other forms of short-term alternative business financing. Unlike traditional interest rates, which are expressed as a percentage and amortize over time, a factor rate is a fixed multiplier applied to the original amount of the advance.
Calculation
[edit]The total repayment obligation for a merchant cash advance is determined by multiplying the advance amount by the factor rate.[1]
Total Repayment = Advance Amount x Factor Rate
For example, a business receiving an advance of $50,000 with a factor rate of 1.5 would be required to repay a total of $75,000 ($50,000 × 1.5). In this scenario, the cost of the capital is a fixed $25,000.
Differences from Interest Rates
[edit]While factor rates and interest rates both measure the cost of borrowing, they function differently in several key areas:
- Format: Interest rates are expressed as a percentage (e.g., 15%), whereas factor rates are expressed as decimals (e.g., 1.1 to 1.5).
- Amortization: Traditional interest is typically charged on the remaining principal balance; as the balance is paid down, the interest accrued decreases. A factor rate is applied to the original principal, meaning the total cost is fixed regardless of how quickly the balance is paid.
- Early Payoff: In many MCA agreements, early repayment does not result in interest savings because the total cost was determined upfront via the factor rate.
- Effective APR: Because MCAs are often repaid over short durations (3 to 12 months) through daily or weekly debits, the effective Annual Percentage Rate (APR) of a factor rate is significantly higher than the decimal suggests. For instance, a 1.3 factor rate repaid over six months may result in an APR exceeding 60-100%.[2]
Determining Factors
[edit]The factor rate assigned to a business is generally based on the risk profile of the merchant. Lenders (often called "funders") evaluate several criteria:
- Industry Risk: Certain industries (e.g., restaurants or trucking) may be assigned higher rates due to perceived volatility.
- Sales Volume: The consistency and volume of a merchant's credit card sales or bank deposits.
- Time in Business: More established businesses typically qualify for lower factor rates.
See also
[edit]- ^ "What Is an MCA Factor Rate? An Accountant's Guide". www.coastaldebt.com. Retrieved 2026-02-02.
- ^ "MCA Loan: What It Is, How It Works". Investopedia. Retrieved 2026-02-02.
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