If you’ve looked into alternative financing solutions like merchant cash advances, you’ve heard the term factor rate. For many business owners, the term ‘factor rate‘can be confusing, since most businesses are used to the term ‘interest rate.’
Usually, with loans, you borrow money and pay interest over the loan period, and the cost is expressed as a percentage. In contrast, a factor rate works differently, and that’s what we’re going to dive into today.
Our team at Bizfund is answering the question, ‘what is a factor rate,’ and delving into a factor rate vs an interest rate. By the end, you’ll have a better understanding of how a factor rate can affect your financing for your business.
Factor Rate vs Interest Rate: A Snapshot View
Because factor rates are structured differently, they can be hard to compare with traditional loans. The table below shows the main differences to give you a better visual understanding:
| Factor Rate | Interest Rate |
| Expressed as a multiplier (for example, 1.15 to 1.35) | Expressed as a percentage (for example, 8% per year) |
| Total repayment is fixed from the start | Total interest depends on time and balance |
| Cost does not change with early repayment | Interest can be reduced if paid off early |
| Typically used for short-term funding like MCAs | Used for loans, lines of credit, and mortgages |
What Is a Factor Rate?
When looking at a factor rate on a business loan in Canada, you need to know what you’re looking at before you sign any agreements.
To keep it simple, now that you’ve seen the table overview, a factor rate is a multiplier and not a percentage. With a factor rate, a lender will apply a fixed multiplier to the amount you receive instead of charging you a factor rate during the duration of your loan. This number determines the total you will repay.
How to Calculate the True Cost
To give you an example, imagine you receive a $50,000 loan at a factor rate of 1.20 with an expected repayment period of 6 months. You need this loan to bring in inventory ahead of peak demand. With this rate, the total repayment would be $50,000 x 1.20, which would equal $60,000.
That means that the cost of your funding is $10,000, regardless of how quickly you repay the sum you borrow. In fact, that is one of the key differences. With a factor rate, the total cost is set upfront, and it won’t decrease if you repay early.
Since your business in this scenario would repay that $10,000 cost over six months rather than a full year, the equivalent annual cost may appear higher when compared to a traditional loan. If you convert that cost to an approximate annual rate, it would fall in the range of 40% to 60%, depending on repayment structure and estimated APR.
However, what matters most in this example is how you use the funding. Since you’re bringing in inventory ahead of peak demand with this funding, if those products sell quickly, the financing supports revenue that wouldn’t have been possible otherwise.
What Affects Your Factor Rate in Canada?
Just as it is the case with interest rates, factor rates aren’t the same for every business. When settling on a rate for your company, lenders will look at several factors:
- Revenue consistency: This is perhaps the most important factor. If you can prove you have steady sales, you will likely be seen as lower risk since repayment is tied to incoming money.
- Time in business: We wish we didn’t have to point this out because it is somewhat unfair, but your time in business also influences the factor rate. If you own a company with a longer track record, you’ll likely receive far more favourable terms than a newer business.
- Your industry: There are some sectors with more predictable cash flow than others, and this can influence the rate you are offered.
In addition to the above, the size of the advance and the repayment structure can also influence pricing. If you take a shorter term and a larger amount, it can lead to different rates depending on the risk involved.
Is a High Factor Rate Always Bad?
To put it simply, a higher factor rate means a higher cost. That in itself isn’t an inherently bad thing. Plus, the more important thing to note is whether the funding makes sense for your situation. Let’s take a merchant cash advance, for instance.
You could use this funding if you need money fast and want it to be flexible, allowing you to use it as you wish for your business. In this scenario, flexibility and quickness matter more than long-term cost.
And you may not see the revenue you would have if you had not applied for the funding, regardless of the factor rate. But it’s still important to make sure you’re being financially responsible.
How to Compare MCA Offers
A merchant cash advance factor rate in Canada can vary significantly from provider to provider. That’s why, when reviewing offers, it helps to look beyond the factor rate alone. What we mean by this is that you should also calculate the total repayment amount.
This can give you a better understanding of the cost in dollars. In addition, you should consider the expected repayment period. If you have a shorter term, you’ll repay faster, which can affect your cash flow.
Also, you may want to understand how a lender would structure repayments. For example, some will tie them to daily sales while others will follow set schedules. If you want to learn more about merchant cash advances before taking the leap, you can have a look at our insights here. We discuss what you need to know to feel comfortable with your decision.
The Wrap-Up On Factor Rates for a Business Loan In Canada
Factor rates are different from traditional interest rates, and that difference can make them harder to understand at first. However, once you break it down, the structure becomes pretty easy to understand.
You receive a set amount, apply a multiplier, and repay a fixed total over a shorter period. But…and there is a but, cost, timing, and how the funding fits into your business plans matter too. That’s why you need to usually consider more than factor rates alone. So, if you want to explore a merchant cash advance and go through a reputable company that will explain factor rates and how they apply to your situation, consider us at Bizfund.
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