APR versus factor rate: how to compare them

What is an APR?

APR stands for annual percentage rate. It is the yearly cost of borrowing, including interest and most required fees such as an origination fee, expressed as a percentage of what you borrowed. Because it is per year and it accounts for the balance falling as you repay, it lets you compare a two year loan with a six month one on the same scale.

Business lenders are not required to disclose an APR in most US states, although a few now require a similar disclosure. So you often have to calculate it yourself or ask. The APR glossary entry covers what is included, and the business loan calculator shows the payment and total cost for any APR.

What is a factor rate?

A factor rate is a multiplier applied once to the amount you receive. Multiply the advance by the factor rate and you get the total you repay. A $50,000 advance at a 1.3 factor rate means you repay $65,000. There is no interest accruing day by day, which is why paying early rarely saves money unless the contract offers a prepayment discount.

Factor rates are used by merchant cash advance companies, some revenue based financing providers and some short term lenders. The number looks small, which is the problem. A 1.3 reads like 30%, but 30% over six months is not 30% a year, and you are not holding the full amount for six months either.

Worked example: what is a 1.3 factor rate as an APR?

Take a $100,000 advance at a 1.3 factor rate, repaid over six months with daily payments on business days.

1. Total payback: $100,000 multiplied by 1.3 equals $130,000. The fee is $30,000.
2. Simple annualized cost: $30,000 divided by $100,000 is 30% for six months. Doubling it to a full year gives 60%.
3. Daily payment: six months is about 126 business days, so $130,000 divided by 126 is about $1,032 per day.
4. Actual APR: because you pay down the balance every day, your average outstanding balance is only about half of $100,000. Paying a $30,000 fee on an average balance of roughly $50,000 over half a year works out to an APR of about 109%, which we round to roughly 110%.

Why is the APR roughly double the simple rate?

Because you never have the full amount for the full term. With daily or weekly payments the balance falls from day one, so by the midpoint you have repaid about half and you are still paying the fee calculated on the whole advance. The money you actually had on average is about half the face amount, which doubles the effective annual rate.

The shorter the term, the higher the APR for the same factor rate. A 1.3 factor rate over 12 months is roughly 55% APR; over 6 months roughly 110%. A renewal or a shorter term at the same factor rate is a large increase in annual cost even though the quoted number did not change.

When does a factor rate product still make sense?

When the money earns more than it costs within the term, and nothing cheaper is available in time. Buying inventory at a discount you can resell in 60 days, covering a payroll gap while a large receivable clears, or taking a contract that needs upfront materials can all justify a short advance. The expected gain should clearly exceed the fee.

It does not make sense for long term needs, for refinancing another advance, or for covering ongoing losses. Stacking a second advance on a first is how businesses get into trouble, and most lenders refuse a stacked file. Check first whether a line of credit or invoice financing fits; they are usually cheaper for the same speed.

What should you ask before accepting a factor rate offer?

Ask for five numbers in writing: the amount you will actually receive after fees, the total payback, the daily or weekly payment, the number of payments, and the APR equivalent. Then ask whether there is a prepayment discount, whether the payment is a fixed amount or a percentage of card sales (a holdback), and whether the contract includes a confession of judgment.

If the provider will not give you the total payback and the APR equivalent, do not sign. You can apply here and compare factor rate offers against term loans and lines side by side, or ask your AI assistant to apply for you through our MCP server; see the agents hub.