Quick overview
Short-term business loans are priced and disclosed in several different ways. Lenders may quote an APR, a factor rate (common for merchant cash advances and some online lenders), or simply a total repayment amount. To pick the least costly option for your business you must convert those different formats into a single comparable metric — either total dollars repaid or an annualized cost such as APR or effective annual rate.
Below I explain each metric, give conversion formulas and step-by-step examples, flag common fees and traps I’ve seen in practice, and point you to useful resources and internal articles for deeper reading.
APR: what it represents and how to use it
Annual Percentage Rate (APR) expresses the annual cost of credit, including interest and certain fees the lender must include under federal rules. APR is useful because it standardizes many common loan charges on a yearly basis so you can compare offers from different lenders (U.S. Truth in Lending Act standards implemented by the Consumer Financial Protection Bureau require consistent APR disclosure) (see Consumer Financial Protection Bureau: https://www.consumerfinance.gov).
What APR does not always show: some lenders for short-term business credit can structure fees so they are excluded from APR calculations or disclosed separately (origination fees taken out of proceeds, fixed transaction fees, prepayment penalties, or split funding). For that reason, always reconcile APR with the lender’s itemized fee schedule and the total repayment figure.
Example (simple): a 12% APR on a 12-month $10,000 loan implies roughly $1,200 of interest over the year, for a $11,200 total repayment (ignoring compounding and extra fees).
Factor rate: what it is and why it’s common in short-term products
A factor rate (also called a purchase factor in the merchant cash advance world) is a single multiplier applied to the principal. If a lender quotes a factor rate of 1.2 on a $10,000 advance, total repayment is $10,000 × 1.2 = $12,000.
Factor rates are simple and direct, but they’re not a time-based rate by themselves — they do not tell you how long you have to repay. That omission makes comparisons to APRs misleading unless you convert the factor rate into an annualized figure.
Range note: factor rates vary widely by product type. Merchant cash advances and some alternative short-term lenders commonly use factor rates in the 1.1–1.5 range (or higher), which can translate to very high APRs for loans with terms under a year.
Converting between factor rate and APR (practical formulas)
Use these conversions when you need an apples-to-apples comparison. The simplest approach converts the factor rate to an annualized percentage assuming no compounding and a fixed term.
- Total repayment = Principal × Factor rate
- Finance charge = Total repayment − Principal = Principal × (Factor − 1)
- Simple annualized APR approximation = (Factor − 1) × (365 / Term days)
Example A — 180-day term
- Principal = $10,000, factor = 1.2
- Finance charge = $10,000 × (1.2 − 1) = $2,000
- APR ≈ ($2,000 / $10,000) × (365 / 180) = 0.2 × 2.0278 ≈ 40.6% annualized
Example B — 90-day term
- Same factor 1.2 on 90 days → APR ≈ 0.2 × (365 / 90) = 0.2 × 4.0556 ≈ 81.1% annualized
These formulas give a quick, conservative approximation for comparison. If the lender compounds interest or charges periodic fees, you’ll need a more exact effective annual rate calculation using cash-flow discounting methods.
Converting APR to a factor rate for a known term:
- Factor ≈ 1 + (APR × Term days / 365)
Example — convert 36% APR for a 120-day loan
- Factor ≈ 1 + (0.36 × 120 / 365) ≈ 1 + 0.1186 ≈ 1.1186
- Total repayment on $10,000 ≈ $11,186
Effective cost metrics: what to calculate and why
Effective cost metrics capture every fee, payment timing, and repayment method so you can compare total cost and cash-flow impact. For short-term loans compute:
- Gross proceeds (amount you actually receive after holdbacks or origination fees).
- Total repayment (principal × factor, or principal + interest + fees).
- Finance charge (total repayment − gross proceeds).
- Effective annualized rate (finance charge / gross proceeds × 365 / term days).
I recommend preparing a small worksheet (or spreadsheet) that lists these items side-by-side for each offer. When I advise clients, we always put offers into the worksheet and look at both total-dollar cost and the effective annualized rate.
Real-world examples and interpretation
Example: Client A needs $15,000 for inventory and receives two offers:
- Offer 1: APR loan — 15% APR, 12-month term, no origination fee. Total repayment ≈ $15,000 × (1 + 0.15) = $17,250.
- Offer 2: Factor loan — factor = 1.25, 180-day term. Total repayment = $15,000 × 1.25 = $18,750. Finance charge = $3,750. APR ≈ 3,750/15,000 × (365/180) ≈ 0.25 × 2.0278 ≈ 50.7%.
Although Offer 2’s factor rate appears as a single easy number, when annualized the effective rate is far higher than the APR loan. Clients sometimes pick the factor rate because of faster funding; our decision needs to weigh cost against the time value of receiving funds sooner.
Common fees and disclosures to watch for
- Origination fees subtracted from proceeds (reduce cash received but usually shown separately). Always compute finance charge based on proceeds, not just nominal principal.
- ACH or processing fees, fixed underwriting fees, and prepayment penalties.
- Holdbacks or split-funding in merchant cash advances that reduce usable proceeds.
- Variable daily repayment percentages in revenue-based financing that complicate annualization.
Regulatory and consumer-protection resources: the Consumer Financial Protection Bureau publishes guidance on small-business and consumer lending costs (https://www.consumerfinance.gov) and the U.S. Small Business Administration provides borrower resources and alternatives (https://www.sba.gov). For protections against predatory short-term lenders consider our internal guide: Consumer Protections Against Predatory Short-Term Lenders: A Practical Guide.
Decision framework I use with clients
- Calculate actual proceeds and total repayment for each offer. Convert to an annualized rate using the formulas above.
- Compare both total-dollar cost and effective APR; ask whether higher cost is justified by speed or certainty of funding.
- Check the lender’s disclosures and sample payment schedule; confirm there are no hidden fees or automatic rollovers.
- Negotiate if possible — lenders often have margin for small rate or fee changes, especially with competing offers.
- Consider alternatives: a short-term line of credit, credit card with a 0% intro APR, or SBA microloans can sometimes be cheaper.
See our related primers on APR mechanics and short-term loan pricing for more depth: APR (Annual Percentage Rate) and Evaluating Effective Annual Cost When Comparing Short-Term Loan Offers.
Common mistakes and misconceptions
- Treating factor rates and APRs as directly comparable without annualizing. That mistake can dramatically understate cost for short-term products.
- Ignoring origination fees or proceeds holdbacks when calculating finance charge.
- Failing to check the repayment schedule for daily or percentage-of-sales draws (common in merchant cash advances).
Final tips and practical checklist
- Ask for a written repayment schedule and an itemized fee disclosure.
- Compute both total dollars repaid and the effective annualized rate.
- If time permits, compare with an SBA or bank line of credit for lower-cost options (https://www.sba.gov).
- When in doubt, bring the offer to a trusted advisor and supply the raw numbers — I regularly review offers for clients to spot hidden costs.
Disclaimer
This article is educational and reflects general practice and examples. It is not individualized financial, tax, or legal advice. Consult a qualified advisor or your lender for guidance specific to your situation.
Sources and further reading
- Consumer Financial Protection Bureau: small-business lending resources (https://www.consumerfinance.gov)
- U.S. Small Business Administration: loan resources (https://www.sba.gov)
- FinHelp related entries: APR (Annual Percentage Rate); Evaluating Effective Annual Cost When Comparing Short-Term Loan Offers; Consumer Protections Against Predatory Short-Term Lenders: A Practical Guide.
