Factor Rates Explained: The Math Behind Merchant Cash Advances

If you’ve ever been quoted a “1.30 factor rate” on a working capital advance, your first instinct was probably to compare it to APR — the way every consumer loan, mortgage, and credit card is quoted. Don’t.

A factor rate isn’t an interest rate. The math works completely differently. Mixing them up is one of the easiest ways to overpay for capital.

How a factor rate actually works

A factor rate is a multiplier. You take your advance amount, multiply by the factor rate, and get the total payback amount. That’s it. The total is fixed from day one.

Example:

• Advance: $50,000
• Factor rate: 1.30
• Total payback: $50,000 × 1.30 = $65,000
• Cost of capital: $15,000

That $15,000 is the entire cost. There’s no compounding. There’s no monthly interest accruing on a balance.

How that compares to APR

APR (annual percentage rate) measures the cost of money on a per-year basis, with interest compounding on the unpaid balance.

A factor rate of 1.30 paid back over 6 months has an effective APR of roughly 60%. A factor rate of 1.30 paid back over 12 months has an effective APR of roughly 30%. A factor rate of 1.30 paid back over 18 months has an effective APR of roughly 20%.

Same factor rate. Wildly different effective APR.

That’s because APR includes time. The longer you stretch the payback, the lower your effective annualized rate, even though the dollar cost is identical.

Why this matters

Two things follow from this math:

1. Don’t compare a factor rate to a bank loan APR directly. They’re not the same metric. Convert factor rate to effective APR using the term length, then compare.
2. Pay them back fast — but only if there’s a prepayment discount. Some MCAs charge the full payback amount whether you pay it off in 3 months or 12. In that case, you’re better off using the full term so the effective APR is lower.

How to know if a factor rate is fair

Industry benchmarks for working capital advances right now:

• Tier 1 (strong file, 1+ year, clean credit): 1.10–1.20
• Tier 2 (moderate file): 1.20–1.35
• Tier 3 (weak file, restored after credit issues): 1.35–1.49+

If your file is strong and you’re being quoted 1.40, someone is taking a margin they shouldn’t be. Get a second offer.

What to ask before signing

• What’s the factor rate?
• What’s the term, in months?
• What’s the daily/weekly payment in dollars?
• Is there a prepayment discount? If yes, what does it look like at month 3, 6, 9?
• What’s the effective APR?

Any honest broker can answer all five in writing. Anyone who can’t is hiding something. That’s not a soft rule — that’s the rule.