Overview

Factor rates are used by alternative lenders to price short‑term business cash advances and revenue‑based financing. Instead of an interest rate plus periodic interest charges, lenders quote a factor rate — a number (commonly between about 1.1 and 1.6) that multiplies the amount you borrow to produce the total repayment amount. Because the factor is applied to the principal, the arrangement looks simpler on its face but can translate into very high annualized costs depending on repayment timing.

How factor rates work — a clear example

  • Loan amount (advance): $10,000
  • Factor rate: 1.30
  • Total repayment: $10,000 × 1.30 = $13,000
  • Implied fee = $3,000

If you repay that $13,000 in a single lump sum 180 days after funding, a simple way to approximate the effective APR is: (fee ÷ principal) ÷ (days/365). Using the example above: (3,000 ÷ 10,000) ÷ (180/365) ≈ 60.8% APR. If repayment happens faster (e.g., 90 days) the effective APR is higher; if repayment is slower the APR is lower. When repayments come as a daily percentage of sales (a typical merchant cash advance collection method), the effective APR calculation becomes more complex and often higher. This demonstrates why factor rates should not be read the same as traditional interest rates.

Why small businesses choose factor‑rate financing

  • Speed: Funding can be approved and funded in days.
  • Flexibility: Less emphasis on credit scores or collateral than bank loans.
  • Revenue link: Repayment models (daily/weekly holds) can match seasonal cash flow.

Common uses: inventory restocks, payroll ahead of busy season, short‑term bridging of receivables.

Costs and tradeoffs

Pros

  • Fast access to capital.
  • Simple math: principal × factor = total due.

Cons

  • Not APR: hard to compare directly to bank loans without conversion to APR.
  • Can be expensive when annualized — effective APRs often reach double digits or higher.
  • Repayments tied to sales reduce daily cash flow and can accelerate repayment during busy periods.

How to compare offers (checklist)

  1. Ask for the factor rate, total repayment, and expected holdback or repayment schedule.
  2. Get the estimated time to repay based on your sales forecast.
  3. Convert the deal to an approximate APR for apples‑to‑apples comparison using the simple formula above or consult a calculator (see CFPB guidance). (Consumer Financial Protection Bureau)
  4. Confirm all fees and prepayment terms in writing.
  5. Compare against short‑term bank lines, SBA microloans, or invoice financing for cost and fit.

Red flags to watch for

  • Lenders won’t provide a repayment schedule or an estimate of time to repay.
  • Contract language that allows unpredictable daily/weekly withdrawals without caps.
  • Confusing fee structures layered on top of the factor rate.

Questions to ask any lender

  • What is the factor rate and what total dollar amount will I repay?
  • How will you collect repayment (daily percentage of sales, ACH, fixed payments)?
  • What is the estimated time to repay based on my current revenue?
  • Are there origination, processing, or late fees? Are they included in the factor?
  • What happens if sales fall and I can’t meet the daily/weekly collection amounts?

Practical scenarios

  • Seasonal retailer: A short advance with a factor rate can cover holiday inventory but plan for steeper cash outflows during high‑sales periods and account for the effective APR.
  • New business: If you lack bank credit and need immediate cash, factor‑rate financing can be an option — but budget conservatively.

Further reading and tools

Authoritative resources

Professional note and disclaimer

In my practice advising small businesses, I’ve seen factor‑rate advances solve cash emergencies but also create tight daily cash flow when repayments accelerate. This entry is educational and not personalized financial advice; consult a CPA or small‑business lender for guidance on your specific situation.

Last reviewed: 2025 (sources: CFPB, SBA, Federal Reserve).