Factor Rate vs APR: Understanding the True Cost of Alternative Financing

When a broker quotes you a "1.3 factor rate," it sounds reasonable. But that number hides the real cost of the money you're borrowing. Understanding the difference between factor rates and APR is critical for any business owner considering alternative financing.

What Is a Factor Rate?

A factor rate is a simple multiplier applied to your advance amount to determine your total payback. If you receive a $50,000 advance with a 1.3 factor rate, you'll pay back $65,000. The math is straightforward: $50,000 x 1.3 = $65,000.

The problem? This number tells you nothing about how expensive the financing actually is. A 1.3 factor paid back over 6 months costs far more than a 1.3 factor paid back over 18 months. But both are quoted the same way.

The APR Reality Check

APR (Annual Percentage Rate) accounts for time. It tells you what you're paying on an annualized basis, allowing you to compare different financing options accurately.

Here's where it gets concerning:

That "reasonable" 1.3 factor rate actually represents extremely expensive capital when you account for the short repayment term. Traditional bank financing typically runs 6-12% APR. You're paying five to ten times that rate.

Why Factor Rates Persist

Factor rates exist because they're easy to explain and don't trigger the sticker shock that APR disclosure would cause. A broker saying "1.3 factor" sounds much better than "70% APR."

This isn't always intentional deception. Many brokers themselves don't fully understand how to calculate true APR on these products. But the effect is the same: business owners don't know what they're actually paying.

The Daily ACH Complication

Most MCAs and revenue-based financing products require daily ACH debits from your business bank account. This creates additional hidden costs:

• Cash flow strain: Daily pulls reduce your available working capital every single day
• Overdraft risk: If receivables don't hit on schedule, you face overdraft fees
• Stacking pressure: When one advance doesn't cover needs, businesses often take another, compounding the problem
• Operational impact: Managing around daily debits distracts from running your business

How to Compare Financing Options

Before accepting any financing offer, ask these questions:

1. What is the total payback amount? Not the factor rate—the actual dollar amount you'll pay.
2. What is the payment term? How many days/weeks/months until the obligation is complete?
3. What is the payment frequency? Daily, weekly, or monthly?
4. Can I prepay early to reduce costs? Many MCAs require full factor payment regardless of when you pay off.
5. What happens if I miss a payment? Understand the default provisions before signing.

Calculating True Cost Yourself

A rough APR calculation for short-term advances:

This is a simplified calculation. The actual APR is higher when you account for the daily compounding effect of ACH payments reducing your principal throughout the term.

When Alternative Financing Makes Sense

This isn't to say MCAs and revenue-based financing are never appropriate. Sometimes they serve a legitimate purpose:

• Bridge financing for a specific, short-term opportunity with clear ROI
• Emergency capital when traditional options are unavailable and the alternative is worse (like losing a key contract)
• Seasonal inventory purchase when the profit margin exceeds the financing cost

The key is understanding the true cost and making an informed decision. Too many business owners sign agreements without realizing what they're actually paying.

What We Recommend

Before accepting any financing offer:

1. Get multiple quotes and compare true total cost, not just factor rates
2. Calculate the APR using the method above (or let us help)
3. Model the cash flow impact of daily payments against your actual receivables timing
4. Review the contract carefully for COJ clauses, prepayment terms, and UCC provisions
5. Consider the alternatives—is there a less expensive path to meet this capital need?