Financial Glossary
Factor rate
A factor rate is a fixed multiplier -- typically expressed as a decimal between 1.1 and 1.5 -- used by alternative lenders to determine the total repayment amount on a short-term business cash advance or merchant cash advance (MCA). Total Repayment = Advance Amount times Factor Rate. Unlike an interest rate, a factor rate does not compound over time and does not decrease as principal is repaid -- it is applied once to the original advance amount. This means early repayment does not reduce the total cost, which is a key distinction from traditional loans where prepayment saves interest. The effective annualized cost of a factor-rate product is often significantly higher than the nominal rate implies, especially for short repayment terms.
Problem & Application
A campground owner takes a $50,000 merchant cash advance at a factor rate of 1.35 to fund an emergency water system repair before peak season. Total repayment = $50,000 times 1.35 = $67,500 -- a $17,500 cost of capital. The lender collects repayment by taking a fixed percentage of daily credit card revenue, with the advance projected to be repaid in 6 months. To calculate the approximate annualized cost: $17,500 cost divided by $50,000 principal = 35% for 6 months, or roughly 70% annualized. This is expensive capital, but the owner calculates that missing peak season entirely due to a failed water system would cost $120,000 in lost bookings -- making the $17,500 financing cost economically rational. Factor-rate products are appropriate only when conventional credit is unavailable and the return on the capital deployed clearly exceeds the cost.
In Short
Factor rates are useful for straightforward financing terms, but borrowers should carefully evaluate the total cost of financing to avoid excessive repayment amounts.