If you've been offered a merchant cash advance or a short-term business loan, your cost was probably quoted as a factor rate. A number like 1.25 or 1.40, not an interest rate. The two look similar. They are not the same thing, and the difference can cost you tens of thousands of dollars.
Here's how each one works, with the math laid out step by step, so you can convert any factor rate into a number you can actually compare.
A factor rate is a decimal multiplier applied to the amount you borrow. Instead of charging a percentage that accrues over time, the funder sets one flat number up front. You'll see factor rates most often on merchant cash advances, short-term business loans, and financing for borrowers with weaker credit. They typically range from about 1.15 to 1.5.
The key feature is this: a factor rate fixes your total cost the moment you sign. It doesn't accrue. It doesn't compound. It isn't tied to time at all.
An interest rate is a percentage charged over a period of time, usually expressed annually as an APR. It accrues on your outstanding balance for as long as you hold the money. Pay the principal down and you owe interest on less. Pay it off early and you stop the meter entirely.
That last point is the whole ballgame. An interest rate is connected to time. A factor rate is not. Everything below flows from that single difference.
There's a quieter consequence worth flagging here. With an MCA, the funder sets the payback period, and the payback period is what drives the factor rate. A longer term means a higher factor rate. The funder controls both levers, and both work in the funder's favor.
Start with the simplest calculation. What you'll actually pay back:
Amount borrowed × Factor rate = Total repayment
Say you take a $50,000 advance at a 1.40 factor rate:
$50,000 × 1.40 = $70,000 total repayment
To find your cost, subtract the amount you borrowed:
$70,000 − $50,000 = $20,000 in financing costs
So far this looks clean. Twenty thousand dollars to borrow fifty thousand, or a 40% cost. That 40% is where most borrowers stop reading, and it's exactly where the math starts to mislead.
Convert the cost into a simple percentage of what you borrowed:
(Factor rate − 1) × 100 = Cost as a percentage
(1.40 − 1) × 100 = 40%
Your brain reads "40%" and files it next to a credit card rate. But this is not an APR. It's a flat fee with no time attached, and a 40% fee paid over six months is a completely different animal than 40% paid over a year. To compare it to a real loan, you have to annualize it.
This is the step funders would rather you skip. To put a factor rate on the same footing as a bank loan, annualize the cost using the length of your repayment term:
(Factor rate − 1) × (365 ÷ Repayment period in days) × 100 = Approximate APR
Take the same $50,000 advance at 1.40, repaid over 6 months (roughly 182 days):
Same deal. Same $20,000 cost. But the honest annualized number is roughly 80%, double the 40% "cost of capital" you were quoted.
Here's the most counterintuitive consequence of a factor rate, and the clearest way to see why it isn't an interest rate.
With a normal loan, paying off early saves you money. You skip the future interest. With a factor-rate product, the $70,000 is owed in full from day one. Paying it off faster doesn't reduce what you owe. It compresses the same fixed cost into a shorter window, which raises your effective APR.
Watch what happens to that same $50,000 advance at 1.40, with its $20,000 fixed cost, at different repayment speeds:
| Repayment Term | Total Cost | Approx. APR |
|---|---|---|
| 12 months (365 days) | $20,000 | ~40% |
| 9 months (273 days) | $20,000 | ~53% |
| 6 months (182 days) | $20,000 | ~80% |
| 4 months (122 days) | $20,000 | ~120% |
The 6-month row is the same deal we annualized above, which is why it lands at 80%. The 40% figure sits at the bottom of the table for a reason. You'd only get there by stretching repayment across a full year, and almost no MCA runs that long.
You pay the exact same $20,000 in every row. But the faster you repay, the higher the real rate you paid. With a factor rate, paying early is a penalty disguised as discipline. The opposite of how a loan works.
If factor rates obscure the true cost, why are they the standard for MCAs? Two reasons, and neither is an accident.
An MCA isn't legally a loan. It's structured as a purchase of future receivables. The funder is buying a percentage of your future sales, not lending you money. That reclassification sidesteps state usury caps that would make an 80%-plus APR illegal as a loan.
APR disclosure rules don't apply either. Conventional lenders must disclose an APR. Because an MCA isn't a loan, it has historically escaped that requirement.
The factor rate, in other words, is the native language of a product built specifically to avoid being a loan.
| Factor Rate | Interest Rate (APR) | |
|---|---|---|
| Form | Decimal multiplier (e.g., 1.40) | Percentage over time (e.g., 12% APR) |
| Tied to time? | No, fixed at signing | Yes, accrues on the balance |
| Total cost | Known on day one | Depends on how long you borrow |
| Early payoff | Saves nothing; raises effective APR | Saves money; lowers total cost |
| Where you'll see it | MCAs, short-term and bad-credit loans | Bank loans, SBA loans, credit lines |
A factor rate and an interest rate are not two ways of saying the same thing. An interest rate measures the cost of money over time. A factor rate is a flat price set at signing, deliberately stripped of the time dimension that would reveal how expensive the money really is.
A note on precision: this formula gives a simplified annualized rate. Because an MCA is repaid through daily or weekly debits, your average outstanding balance is actually much lower than the full $50,000, which means the true APR is often even higher than this estimate. Either way, the real cost is far above the factor-rate figure.
