A merchant cash advance (MCA) is an alternative loan option for businesses. If traditional loans aren’t a good fit for a small business or they’re seeking something small, immediate, or short-term, MCAs are another potential avenue.
There are a few key differences between the two. Repayments are often based on the percentage of debit or credit card sales, so the time it takes to repay the advance varies. Perhaps the biggest difference, the one discussed in this article, is factor rates. Instead of charging interest, MCAs use something called “factor rates” to determine the fees attached to the borrowed money.
What Determines Your Factor Rate?
Factor rates are determined by multiplying your original loan amount by a certain number. Typically, factor rates range between 1.1 and 1.5, but it depends on your lender and the established agreement. A few things affect your factor rate, such as:
- Credit score – Business credit history and personal credit score are both possible factors.
- Years in business – MCAs have looser requirements then lenders working with traditional loans. Businesses typically need to be in operation for at least six months to qualify, though.
- The industry you’re in – Certain industries have periods of high and low sales. The lack of consistency could mean a higher factor rate.
- Average number of sales – MCA repayment is usually linked with credit or debit card sales, so your average number of sales directly correlates with your ability to repay the advance.
- Stability of income or sales – Like the number of sales, stability, and level of income indicates your ability to repay.
Your factor rate will likely be higher if repayment is risky. If you have low or unstable sales, run a new business, or generally seem like a risk, you’ll end up with a higher factor rate.
How Much Will You Pay?
Your final payback amount is determined by multiplying your factor rate by the original amount. For example, if the original MCA amount is $15,000 and your factor rate is 1.1, your final repayment amount is $16,500. That puts the cost of getting the advance at $1,500.
Unlike interest rates, which change depending on the remaining balance, the factor rate is always the same. Your repayment amount is set and won’t change. In some cases, that means the MCA is more expensive than a traditional loan, but it’s still a viable option for businesses in need of quick cash.
Are Factor Rates Better than APR?
Factor rates are sometimes preferable to APR, but it depends on your priorities. Overall costs with APR could be lower than factor rates, but it’s easier to calculate the full cost using factor rates. In the end, if an MCA satisfies the needs of a business more than a traditional loan (or if that business doesn’t qualify for a traditional loan), factor rates come with the package.
Final Thoughts
MCAs have flexible qualifications compared to other lenders. Even when factor rates push the final cost higher than traditional loans, they’re an option for businesses in a bind.