What is a Factor Rate and How to Calculate It
A factor rate, often used in business financing, particularly for merchant cash advances (MCAs) and short-term business loans, represents the cost of capital. Unlike interest rates which are expressed as a percentage over a period, a factor rate is a multiplier applied to the original amount borrowed. It simplifies the calculation of the total repayment amount.
How Factor Rates Work
When you receive a cash advance or a short-term loan, you'll be given a factor rate. For example, a factor rate of 1.2 means that for every $1 you borrow, you will repay $1.20. The total repayment amount is calculated by multiplying the amount you received by the factor rate.
The period over which this repayment is made, and the frequency of payments (e.g., daily, weekly), are separate terms of the agreement. The factor rate itself only tells you the total amount to be repaid, not how quickly.
Why Use a Factor Rate?
- Simplicity: It provides a straightforward multiplier for calculating the total repayment.
- Predictability: Businesses can easily determine the total cost of the advance upfront.
- Common in Alternative Lending: It's a standard term in the merchant cash advance industry.
Calculating the Factor Rate
The factor rate can be calculated if you know the total repayment amount and the initial amount advanced. The formula is:
Factor Rate = Total Repayment Amount / Amount Advanced
Understanding this calculation is crucial for comparing different financing offers and ensuring you are aware of the true cost of the capital.