Overview

Factor rates and APR both describe borrowing cost, but they do it very differently. A factor rate gives a straight multiplier for total repayment; APR annualizes interest and fees so you can compare products that have different timelines and fee structures. Because short-term products are paid back quickly or with variable daily/weekly collections, a modest factor rate can translate to a very high APR.

How to calculate and compare (simple conversions)

  • Factor-rate math: Total repayment = Principal × Factor rate.
  • Example: $10,000 with a 1.2 factor rate → Total repayment = $12,000; cost = $2,000.
  • Approximate APR conversion for a fixed-term loan:
  • APR ≈ (Total cost / Principal) ÷ (Term in days / 365)
  • Example (6 months ≈ 182 days): APR ≈ (2,000 / 10,000) ÷ (182 / 365) = 0.2 ÷ 0.5 ≈ 40% APR.

Important: This conversion is an approximation. Many short-term products (merchant cash advances, daily remittance loans) use fixed holdbacks or percentage-of-sales remittances, producing a front-loaded effective interest that standard APR formulas understate. For irregular repayment schedules you need an amortization schedule or an IRR-based conversion to compute an accurate APR.

Real-world differences and regulatory context

  • Usage: Factor rates commonly appear in merchant cash advances and some short-term merchant funding products where lenders buy future receivables or set a fixed-payback multiplier. APR is the standard disclosure under the Truth in Lending Act for consumer credit, but many business financing arrangements are not subject to TILA’s APR rules. (See Consumer Financial Protection Bureau guidance on small-business products and merchant cash advances.)

  • Transparency: APR attempts to include fees and spread costs over a year so consumers can compare offers. Factor rates disclose total repayment but don’t reveal time value of money or how fast the balance is paid down.

  • Cost perception: A 1.2 factor rate looks like a 20% cost if you only compare total dollars. But because repayment often occurs in weeks or a few months, the annualized rate can be 2–5× higher than 20% once you convert to APR.

Examples

1) Shorter term increases APR dramatically

  • $10,000, factor 1.2, repaid over 3 months (91 days): APR ≈ 20% ÷ (91/365) ≈ 80% APR.

2) Longer term lowers annualized rate

  • Same factor 1.2 repaid over 12 months: APR ≈ 20% ÷ (365/365) = 20% APR.

Why this matters for businesses

  • Cash flow: Factor-rate products often collect via daily credit-card remittances or fixed ACH, which can pressure daily cash flow. Ask for a simulated payment schedule before signing.
  • Comparability: Use APR—or better, a dollar-total cost and a clear repayment schedule—to compare offers. If the lender won’t provide an amortization or sample repayment table, treat the offer as opaque.

Practical steps to evaluate offers

  1. Ask for total repayment, holdback percentage (if applicable), expected repayment timeline, and an example amortization. If you get only a factor rate, ask the lender to show how quickly they expect to be repaid.
  2. Convert a factor rate to an approximate APR using the formula above to compare with term loans. For irregular payments, request an IRR-based effective APR calculation.
  3. Compare total dollars repaid and the timing of each payment. A lower total cost with front-loaded payments can still harm short-term liquidity.
  4. Check whether the product is governed by consumer-protection laws or is a business financing product (merchant cash advances and some short-term business loans often fall outside TILA). See CFPB guidance for details. (Consumer Financial Protection Bureau)

Common mistakes I see in practice

  • Focusing only on the multiplier: Many business owners assume a 1.2 factor is ‘only 20%’ without converting to an APR. In my practice I’ve seen clients accept offers that looked cheap until we modeled the effective APR and daily cash impact.
  • Ignoring fees and prepayment effects: Some products add processing fees, origination fees, or require ongoing withholding that changes the effective cost.

When APR is the better comparison metric

Use APR when you must compare offers with different terms, explicit fees, or when you need an annualized view of cost. APR is especially useful for term loans and installment products where payments and interest accrue in predictable ways.

When a factor rate might be acceptable

A factor rate can be acceptable for very short-term needs if you fully understand repayment timing, impact on cash flow, and total dollars repaid. But treat it as a red flag if the lender refuses to show a repayment schedule or refuses to convert the quote into an annualized figure.

Helpful resources and internal guides

Authoritative sources

Professional disclaimer

This article is educational and not personalized financial advice. Consult a licensed financial or legal professional about specific financing decisions.