Factor Rate vs. Interest Rate: Understanding Small Business Loan Rates & Fees

Because there are so many terms to describe the various loan fees you’ll pay, calculating the total costs of borrowed capital can be confusing for some business owners and financial decision-makers.

Knowing how to distinguish between factor rates and interest rates plays a vital role, however, in determining your total borrowing costs. Understanding the key differences we highlight below between the two pricing models will help simplify the process of determining which funding option is best for your business.

Factor rates and interest rates account for two of the most commonly used approaches lenders use to price business loans and other forms of financing. Factor rates are usually expressed as a decimal number and represent a flat fee within your loan that lenders charge based on the total disbursement amount.

Interest rates, on the other hand, are figured as a percentage. They are calculated on the basis of the total amount borrowed. Once you understand the distinction between factor rates and interest rates, you’re in a better position to encounter cost-effective financing options for your business and keep your borrowing costs low.

In this post, we will explore the differences between factor rates and interest rates before providing a concise overview of how to calculate your total borrowing costs.

We’ll discuss the advantages and disadvantages of each, in addition to how you should compare the two and make an informed decision about which financing option is best for your business.

By the end, you’ll understand how to evaluate the costs associated with taking out a small business loan and decide if a factor rate or interest rate is best for your specific application.

What are factor rates?

The factor rate accounts for one of several core concepts in business finance. Lenders use them to establish the cost of securing capital. Factor rates express themselves as a percentage of the total amount borrowed. Creditors use this formula to calculate the total amount you’ll pay on a loan before presenting those fees to borrowers in their loan offers. The associated costs include the principal, any applicable fees, and the factor rate itself.

Factor rates are determined by the creditor, while loan pricing takes into account the borrower’s creditworthiness and the type of loan requested. Higher credit scores and shorter terms usually result in lower factor rates, and vice versa. Likewise, the amount borrowed and the industry you’re operating in also affect the factor rate.

After getting a handle on factor rates, you’ll be in a better position to explore your financing options. Knowing how factor rates work will help you evaluate the cost of obtaining capital and ensure you select the best loan terms to suit your unique operations.

Factor interest rates often vary widely between lenders, so remember to shop around and compare offers to avoid paying too much for your loan. In business funding, the average factor rates fall between 1.1 and 1.5.

What are interest rates?

Business loan interest rates are essential for evaluating your total borrowing costs. When estimating loan pricing, you need to consider the interest rate and how it impacts the total fees you’ll pay over the life of your loan.

Interest rates, like factor rates, can also differ from lender to lender and are generally determined by aspects such as the size of the loan, the borrower’s creditworthiness, and the intended use of the loan.

You can take out fixed-rate funding, meaning the rate will remain the same for the duration of the loan. Business lenders offer variable-rate products too, where the rate may fluctuate with an external benchmark. A fixed interest rate can provide borrowers with certainty and stability, whereas a variable interest product can offer the potential of lower interest payments if the benchmark rate falls.

When calculating the cost of a loan, remember to evaluate all the associated costs, including fees, closing fees, and interest rates. This approach helps you save money in the long run. Consider, as well, that the lowest interest rate is not always the best deal. As a borrower, you should analyze every aspect of your loan carefully to determine if fits your requirements.

Factor rate vs interest rate: a side-by-side comparison

Interest rates and factor rates are two different concepts, but they’re both used to price business loans. If you’re seeking capital, understanding how interest rates factor rates compare and contrast can translate to significant long-term savings.

Factor rates are the fees lenders charge based on a set percentage of the amount borrowed. This rate is determined by the lender and is usually applied as a one-time fee. Factor rates are often higher than interest rates because the lender takes on more risk by extending a loan with no interest payments. Most companies use factor rates in their short-term financing solutions, and these types of loans are typically reserved for businesses only.

Interest rates, on the other hand, are calculated as a percentage of the amount borrowed. The lending fees work themselves into the loan as periodic payments over the specified term and can vary based on the type of loan and borrower credit score. Interest rates are lower than factor rates most of the time. You can use interest-rate loans to obtain both personal and business capital.

Factor rates and interest rates, in sum, represent two distinct concepts lenders rely on to establish risk-based pricing on their loans.

How are factor rates determined?

Business lenders often use factor rates to determine how much a borrower will pay in interest and fees for financing. A factor rate is an interest rate expressed as a single multiplier as opposed to a percentage rate. Lenders base this multiplier on the borrower’s creditworthiness, the size of the loan, and the length of the repayment term.

When evaluating your borrower profile, the lender will assess your creditworthiness by looking at your payment histories and both your personal credit and business credit score if you have one. They will then determine the risk your business and you present.

To obtain your personal FICO score, the lender runs a credit check to assess the Your ability to repay the loan. Creditors also look at the size of your loan, the length of the repayment term, and your existing cash flows to establish the factor rate for the financing it intends to offer you.

You can use the factor rate to calculate the total cost of the loan. The borrowing expenses include the loan’s principal and any fees associated with originating the funding. The factor rate also tells you your total repayment amount. When you understand how the factor rate works, you safeguard yourself against overpaying for your next business loan.

To recap, factor rates are:

• Determined by the lender and are based on a variety of factors, including the borrower’s credit score and financial history.
• Based on the borrower’s ability to repay the loan.
• Lower if your credit score is high.
• Established by loan type and total loan dispersal amount.
• Key factors in determining interest rates and repayment terms.

Before applying for your next business loan, be sure to have a firm grasp of factor rates because this will help you choose the best loan product that offers the most competitive terms and pricing.

What is the factor rate formula?

Businesses can use the factor rate formula to calculate the cost of a loan. Knowing this formula helps determine the total cost of a loan and whether or not you’re making a reliable financial decision. The formula takes the principal amount of the loan, the factor rate, and the duration of the loan into account to calculate the total cost of the offer.

The factor rate is expressed as a percentage and calculated by dividing the total cost of the loan by the principal amount. This rate is then multiplied by the term of the loan to determine your loan’s total cost.

For example, if a business takes out a loan of $5,000 with a factor rate of 1.2% and a term of three months, then the total cost of the loan would be $6,000 ($5,000 x 1.2% x 3 months). Knowing the factor rate formula helps you make an informed decision about the cost of a loan and whether it is the right choice for your business.

Converting factor rate to APR

The annual percentage rate (APR) is a key metric for evaluating the cost of a loan. You should understand how to convert a factor rate to APR because it gives the most reliable picture of your real-world borrowing costs. Here’s how it works.

First, make sure you comprehend the factor rate described above. To reiterate, the factor rate is a type of rate used by alternative lenders and is expressed as a multiple of the loan amount, rather than a percentage. For example, if a factor rate is 1.2, that means that the borrower pays 1.2 times the loan amount in total interest and fees.

To convert a factor rate to APR, simply divide the factor rate by the number of months in the loan term and then multiply the result by 12. To make the calculation easier, you can always use a Factor Rate to APR calculator.

Here are three examples of how to convert factor rate to APR:

• For a 3-month loan with a factor rate of 1.2, the APR would be 48%.
• For a 6-month loan with a factor rate of 1.35, the APR would be 45%
• For a 12-month loan with a factor rate of 1.5, the APR would be 15%.

Making an informed loan decision about which loan is best for your business can be a challenge. But when you know how to convert a factor rate to APR, you’re in a much better position to select the right loan product.

How should you choose between factor rates and interest rates?

The decision between factor rates and interest rates is frequently a difficult choice for small business owners. Before you commit, you need to weigh the pros and cons of each option so you don’t overpay for your loan.

Factor rates tend to be more attractive to small business owners because they allow for immediate access to funds. Also, the total amount you’ll pay is determined by a single fee.

The rates are almost always higher than interest rates, however, making factor rates the more expensive solution over the long run. Factor rates require a personal guarantee, which means these loans a risky proposition when faced with business owners who may not be able to cover their losses if the business fails.

Interest rates, on the other hand, are typically lower than factor rates and are spread out over the duration of the loan. This is beneficial for companies that need a longer-term loan structure, as the total cost of the loan will be lower than that of a factor rate loan.

Interest rates can be effective solutions for businesses with a stable cash flow, since the loan payments spread themselves out over the loan term. The trouble with interest rates, though, is that they can be more difficult to qualify for than factor rates due to stricter lending requirements.

Ultimately, you should base your decision between factor rates and interest rates on the specific needs of your company. Consider the advantages and disadvantages of each option, and work with an experienced business banking partner like New Bridge Merchant Capital to help guide you on your decision.

Searching for alternative business funding?

Alternative lending solutions, such as merchant cash advances and factor rate funding, offer businesses a vast range of advantages compared to traditional financing options. The loan application process is more streamlined, with less paperwork, and these products often come with more lenient approval requirements.

Furthermore, the processing time is significantly reduced, with funding often available within a single business day. Alternative financing solutions ultimately offer more flexibility when it comes to negotiating the terms of your business loan.

Learn more about alternative funding by connecting with New Bridge Merchant Capital on our website or reach out to a dedicated business finance specialist now at 844-228-0593.