Why a factor rate understates the cost so badly
An interest rate accrues on a declining balance: as you repay, you owe interest on less. A factor rate does not. The total repayable is fixed the moment you sign - advance multiplied by factor - and you pay it down continuously while having use of steadily less of the money.
That is why a 1.3 factor over six months is roughly twice as expensive, in APR terms, as the same 1.3 factor over twelve. The shorter the term, the higher the true cost of an identical-looking headline number.
Fees deducted from the wire
Origination, underwriting, and ACH set-up fees are commonly deducted before funding. You never have use of that money but you repay against it, so it belongs in the APR calculation. This calculator subtracts it from the amount received, which is the correct treatment and the one most funders' own illustrations omit.
What the disclosure laws now require
Several states - New York, California, Utah, Virginia, and others - now require providers of commercial financing under a threshold amount to give standardised disclosures including an estimated APR and total cost before you sign. Where you are entitled to one, read it and compare it against what you were told verbally.
Questions
- What APR is a 1.4 factor rate?
- It depends entirely on how long repayment takes. Over 12 months a 1.4 factor is roughly an 80% APR equivalent; over 6 months the same factor is roughly 170%. The factor rate alone tells you nothing about the cost of the money.
- Why does repaying early not save me money?
- Most advance agreements fix the total purchased amount regardless of how fast you deliver it. Unlike a loan, there is no unaccrued interest to save. Some funders offer an early-delivery discount, but it is a contractual concession that has to be written in.
- Is a merchant cash advance ever the right choice?
- When the money funds something that returns more than the true APR, faster than the repayment term, and no cheaper capital can arrive in time. That is a narrow window, and it is worth checking an SBA Express line, factoring, or a CDFI first.