What is Rate Factor on Interest?
If you’re seeking funding options for your business, you’ve no doubt come across a few terms, such as rate factor or payment factor. And you’re not alone if you’re asking “what is payment factor” or “what is a factor rate?”Many people may not be familiar with these terms, especially if they haven’t sought business funding before.
To help clear things up, we’ve written this post to explain what these terms actually mean.
What is the Interest Rate Factor?
The interest rate factor is simply the amount you have to pay back in interest when you take out a loan. It’s also called payment factor or flat fee because you can look at it as a fee charged on top of your loaned amount. It’s usually expressed as a daily or monthly factor rate and in the form of a decimal number ranging from 1.1 to 1.9 (as opposed to a percentage, as is the case with interest rate).
The use of interest rate factor is less common than the more familiar APR. That’s because the former is only ever used in short-term business loans such as a business cash advance, where payments are made daily or weekly instead of monthly.
How Does Factor Rate Compare to Interest Rate?
The familiar interest rate (also called the annual percentage rate or APR) is the portion of your loan amount that is subject to interest. It tells you how much you owe on any given pay period during the loan’s duration. It compounds and changes as your debt decreases over time.
The rate factor, on the other hand, doesn’t change and only applies to your original loan amount.
Interest rate and factor rate are simply two metrics to describe your interest payments. However, the two are linked, such that you can derive your APR from your factor rate, and vice versa. Let’s explore how to calculate interest factor rate next.
How to Calculate Interest Rate Factor
The interest rate factor formula is pretty simple — just multiply the factor rate by your loan amount. Say you took out a loan for $200,000 at a rate factor of 1.3. Your total repayment will then be $260,000. Divide this by the number of days or months to get your daily or monthly repayment amount, respectively.
Here’s how to get interest rate factor if you know your APR. Start by converting the APR (a percentage amount) into a decimal figure. So an interest rate of 7.50% becomes 0.075. Next, divide this decimal by 365.25, which is the number of days in a year plus an extra 0.25 to account for leap years. Multiply this amount by your loan balance to get your daily repayment amount.
How is Interest Rate Factor Determined?
As factor rate is mostly a metric used in business loans, it’s determined based on certain aspects of your business. These include how long your company has been doing business and its seasonality. Financial performance is, of course, always a requirement and can be shown with revenue reports and sales forecasts.
Interest Rate Factor vs Interest Rate
Let’s start with interest rates. Since they’re mostly applied to secured, long-term loan products, they usually appear as lower or cheaper overall. Monthly payment amounts are smaller as well, making interest rate loans more manageable.
The problem is that secured loans associated with interest rates take longer to process (sometimes taking months for larger amounts). The requirements are also very stringent, including having a higher credit score and longer business tenure. While monthly payments are lower, the longer periods mean you may end up paying more overall.
On the other hand, the rate factor is often applied to fast, unsecured loans. That means faster processing time and fewer requirements. Typically, you don’t need to have a stellar credit history nor have a company that’s existed for years to qualify.
The drawback of unsecured loans, however, is that the APR is higher and the repayment terms are bigger and more frequent (daily or weekly).
Which is Best for You?
Often, you don’t even need to worry about choosing, as the type of funding or the lender will determine that for you.
But if you have a choice, it will depend on your business’s needs. You should factor in where you’ll be using the funds, how much you need, and your business’s financial standing.
For example, if you only need a short-term cash infusion to help cover lean months, then a cash advance will work much better (meaning factor rates will apply). For bigger business expansions, however, a longer-term loan with lower interest rates might be a better choice.
Unsure Which One to Pick? L3 Funding Can Help!
In the end, it can be hard for you to decide on your financing options with so many choices available. As a result, it might be worthwhile to seek professional advice from our experts at L3 Funding. We cover a wide variety of flexible merchant funding solutions with better rates and longer terms. Contact us today to learn more.