What is a factor rate and how to calculate it
Key takeaways
- Factor rates are a fixed fee multiplied by the entire loan up front, which means that you’ll pay the entire fee even if you pay the loan off early
- To compare loans with traditional interest rates and factor rates, you’ll need to convert factor rates to interest rates
- Factor rate loans can come with interest rates of 50 percent or more, so understand the full cost before signing the loan agreement
If you take out a short-term loan, a bad-credit loan or a merchant cash advance, you might be charged a factor rate instead of an interest rate.
Factor rates are decimals that the lender uses to calculate the cost of the loan. While it’s simpler to use a factor rate to find out how much you’ll be paying, factor rates tend to cost much more than interest rates. Factor rate loans can cost as much as 50 percent of the loan balance, not including fees.
Before signing for a factor rate loan, you’ll want to understand how to compare factor rates to interest rates to make sure you’re getting a fair loan offer.
What is a factor rate?
A factor rate is a fee that gets applied to your business loan instead of using a traditional interest rate. It is expressed as a decimal like 1.10 or 1.40 that gets multiplied by the principal loan amount. It’s used in place of the interest rate and is often found with high-risk loans available to business owners with bad credit.
You might see factor rates used with loans such as:
- Merchant cash advances: Advances against your business’s future credit and debit card sales
- Business lines of credit: Lines of revolving funds that you can use as needed and borrow from again as you repay previous loans
- Short-term loans: A loan with a set repayment term, typically 24 months or less
- Bad credit business loans: Loans for business owners with low credit scores or limited credit history
How do factor rates work?
Factor rates work by multiplying the decimal by the entire loan amount upfront. Factor rates typically range from 1.10 to 2 and only apply to the original amount of money borrowed.
Factor rates are a fixed cost, meaning that each repayment will be the same amount of money. However, because factor rates are calculated at the beginning of the loan, you’ll be on the hook to pay the entire fee even if you pay off the loan early.
Factor rate vs. interest rate
| Type of fee | Description | How it’s calculated | Loan fees incorporated into cost? | Does early repayment save money? |
| APR | Expressed as a percentage like 8.00% | The loan principal is multiplied by the percentage each week or month that the repayment is due | Yes | Yes, unless there’s a prepayment penalty |
| Factor rate | Expressed as a decimal like 1.10 or 1.40 | The loan principal is multiplied by the decimal at the beginning of the loan | No | No, unless the lender offers a prepayment discount |
Most business loans calculate the interest rate with each payment, typically monthly. The interest rate is expressed as a percentage, which is multiplied by the current balance of the loan. As your balance decreases, the amount of interest you pay decreases as well. Since the interest is calculated with each payment, if you pay back the loan early, you typically save money on interest.
By comparison, loans with a factor rate apply the fee at the beginning of the loan. While this simplifies the calculation, it often leads to higher borrowing costs than a loan with an APR. You will be responsible for paying the entire factor rate fee even if you pay off the loan early. However, some lenders provide a discount for early repayment.
Some lenders charge a prepayment penalty, which is a fee that can help lenders make up for the interest income they lose when borrowers pay back loans early. Check how the lender handles prepayment if you plan to pay off your loan early.
How to calculate a factor rate
Using the factor rate provided by the lender, you can quickly calculate the cost of the borrowed funds.
For example, if you borrowed $100,000 with a factor rate of 1.5, multiply those two figures together — $100,000 x 1.5. This gives you $150,000, the total amount you’ll need to repay.
If you want to know the total fees you’ll be charged, you would subtract the amount borrowed from the total loan cost: $150,000 (total loan cost) —$100,000 (original loan amount) = $50,000 (total fee charged). The $50,000 is the cost of borrowing the original $100,000.
Loans with factor rates tend to have short repayment periods of 24 months or less. If it took you two years to pay off a $100,000 loan with $50,000 in interest, you’d pay the equivalent of more than 42 percent interest per year.
How lenders determine factor rates
Lenders use similar factors to determine what factor rate to give you as they do interest rates. In general, a borrower with a strong credit history and strong revenue will get the lowest factor rates.
- Credit history. Borrowers with high credit scores like 670 or higher may qualify for the lowest factor rates. However, if you have strong credit, consider whether a loan with an APR offers better rates.
- Current financial profile. How much revenue does your business currently bring in and how steady is that revenue? Strong revenue proves that your business is able to easily manage the business loan.
- Current debts. If you have current debt, lenders may determine whether you can handle new debt. Lenders may use your debt-to-income ratio or debt service coverage ratio to evaluate your business. Businesses with no debt are more likely to get approved for the lowest factor rates.
- Repayment term. Very short repayment terms may have higher factor rates so that the lender gets a higher return for lending to you.
How to convert a factor rate to interest rate
It’s difficult to compare loan products when one is quoted with a factor rate and the other as an interest rate or APR. To better understand what you’d actually pay, you can convert the factor rate to interest rates.
While this conversion doesn’t consider fees you may be charged like an APR would, it can give you a better point of comparison between the two loan products.
You’ll want to convert a factor rate to an annual interest rate so that you can see whether the factor rate loan or APR loan offers the better rate. Without converting the factor rate, you may choose the loan with a higher borrowing cost.
Here are two methods for converting a factor rate to interest rates.
Method one
Step 1: Subtract 1 from the factor rate
Step 2: Multiply the decimal by 365
Step 3: Divide the result by your repayment period
Step 4: Multiply the result by 100
Here’s an example using the $100,000 loan with a factor rate of 1.5 and a two-year (730 days) repayment period:
Step 1: 1.50 – 1 = 0.50
Step 2: .50 x 365 = 182.50
Step 3: 182.5 / 730 = 0.25
Step 4: 0.25 x 100 = 25%
If you want to convert factor rates to annual interest rates using your loan amount, try method two.
Method two
Step 1: Find the overall loan amount by multiplying the amount to be borrowed by the factor rate. Example: $100,000 x 1.5 = $150,000
Step 2: Find the total interest by subtracting the original amount borrowed from the overall loan amount. Example: $150,000 – $100,000 = $50,000
Step 3: Convert the total interest cost to a percentage by dividing the total interest costs by the original amount borrowed. Example: $50,000 / $100,000 = 0.5 (50%)
Step 4: Find the annual interest rate by multiplying the percentage by the total number of days in a year. Example: 0.5 x 365 = 182.5.
Step 5: Then, divide that figure by the number of days in the repayment period.
Example: 182.5 / 730 = 0.25 or 25%
Just like with method one, this gives you an annual interest rate of 25 percent.
How much a loan costs with a factor rate
The higher your factor rate, the more you’re going to pay on the loan. While factor rates don’t have compound interest, they do tend to be higher than interest as a whole. They also tend to have a more aggressive repayment schedule like weekly payments.
To illustrate the cost of a factor rate, here’s what you’ll pay for a 12-month loan based on different factor rates.
| Loan amount | $100,000 | $100,000 | $100,000 |
| Factor rate | 1.1 | 1.5 | 2 |
| Interest rate | 10% | 50% | 100% |
| Monthly payment | $4,583.33 | $12,500 | $16,666.67 |
| Total interest paid | $10,000 | $6,500 | $8,333.33 |
This is the key downside of business loans for bad credit – they tend to come with higher factor rates, and thus cost more than loans with an APR.
Bottom line
Factor rates are used instead of interest rates to determine the total cost of the loan. They’re typically used with bad credit business loans, including merchant cash advances ,short-term loans and some business lines of credit. Before signing up for this type of financing, it’s important to know exactly how much you’ll be charged and how the factor rate compares to interest rates. This will help you compare various loan products and make the best decision for your business.
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