What is a factor rate?

A factor rate expresses the price of money as a proportion of the amount borrowed rather than as a rate per year. When a funder quotes 1.25, it is saying that for every pound it advances, one pound twenty five pence comes back. Nothing in that statement refers to a period, which is why you will never see a factor rate expressed as a rate per month or per annum.

In a merchant cash advance the reason for that convention is structural. The funder is not lending; it is buying an agreed amount of your future card sales at a discount. The factor rate is the discount, expressed the other way round. Because the funder has bought a fixed quantity of receivables, the amount it expects back was settled at the moment of purchase and cannot change according to how long the sales take to arrive.

That is why the factor rate is best read as a total cost of capital figure rather than a rate. It answers the question how much will this cost me, completely and immediately. It does not answer the question is this expensive, because that depends entirely on how long you have the money.

The formula runs in both directions, and you will need both.

• To find the total repayable: advance multiplied by factor rate. A 25,000 pound advance at a factor rate of 1.2 gives 30,000 pounds repayable.
• To find the cost: advance multiplied by the factor rate minus one. The same deal costs 25,000 multiplied by 0.2, which is 5,000 pounds.
• To work backwards from a quote: total repayable divided by advance. If a funder offers 40,000 pounds and asks for 48,000 pounds back, the factor rate is 48,000 divided by 40,000, which is 1.2.

That last calculation is the useful one, because not every offer leads with the factor rate. Some funders present only the advance and the total repayable, which is clearer at a glance but makes comparison across offers harder. Convert everything to a factor rate first and the field flattens out. Our factor rate calculator does the arithmetic if you would rather not.

One conversion that does not work is factor rate into a percentage cost per year. Subtracting one and multiplying by a hundred gives you the total cost as a percentage of the advance, which people sometimes mistake for an annual rate. A factor rate of 1.3 is a 30% total cost, not 30% a year. Over eight months it is considerably more than 30% a year; over two years it is considerably less.

A factor rate of 1.1 is the cheapest end of the normal range. It means a 10% total cost: borrow 10,000 pounds, repay 11,000 pounds. In the UK it is generally reserved for well established merchants with a long, stable record of card takings, and often for advances offered by the payment provider that already processes those takings and can see the data directly.

Most UK offers cluster between 1.18 and 1.35. Rates above 1.5 exist, usually where trading history is thin or the advance is large relative to turnover, and at that level we would want a very clear commercial reason for taking the money at all.

There are three reasons, and only one of them is about presentation.

The first is legal structure. An advance against future card takings is a purchase of receivables, not a loan. Interest is the price of credit, and where there is no credit agreement there is nothing for interest to attach to. A fixed purchase discount is the coherent way to price it.

The second is that the repayment period is genuinely unknown. Repayment happens as a percentage of daily card takings, so the funder does not know whether it will get its money back in five months or fifteen. An interest rate on an unknown term produces an unknown total. A factor rate produces a known total on an unknown term, which is the risk allocation both sides can actually live with.

The third reason is that it looks cheaper, and it would be naive to pretend that is irrelevant. A factor rate of 1.35 reads as a modest number. Expressed as an annualised cost on a nine month repayment it is well into three figures. Funders are not obliged to make that translation, and most do not. That is not necessarily bad faith, but it does mean the burden of comparison falls on the business taking the money.

The distinction comes down to what happens after day one.

The practical consequence is that a factor rate rewards you for taking your time and an interest rate rewards you for repaying quickly. If your card takings surge and the advance clears in four months rather than ten, you have paid the same money for less than half the use of it. We look at the arithmetic of that conversion, with worked APR equivalents, on our page on factor rate versus APR.

These two terms get used interchangeably and they describe different things. A factor rate is the multiplier described on this page. A factoring rate is the fee charged under an invoice finance arrangement, where a provider advances a percentage of an unpaid invoice and charges a service fee plus a discount charge until the customer settles.

The mechanics differ in a way that matters. Invoice finance charges typically do accrue with time, because the provider is exposed for as long as the invoice remains unpaid, so a customer who pays in thirty days costs less than one who pays in ninety. Invoice finance is also priced against the creditworthiness of your customers rather than your own card takings, which makes it a business to business product where a merchant cash advance is naturally a consumer facing one. We compare the two on our page covering a merchant cash advance against invoice finance.

Factor rate pricing shows up in a fairly narrow band of the UK market:

• Merchant cash advances. The classic case, and the one this site covers in depth.
• Revenue based finance. Structurally similar, repaid as a share of total revenue rather than card takings alone, and commonly priced on a factor rate or a flat fee that behaves the same way.
• Some short term business loans. A number of alternative lenders quote a fixed total repayable on terms under twelve months, which is a factor rate whether or not they use the phrase.

You will not normally see factor rates on a bank business loan, on a revolving credit facility or on an overdraft, because those products charge for time and need a rate that responds to it. A revolving credit facility in particular is the natural opposite: you draw what you need, pay interest only on what is drawn, and stop paying when you repay. That flexibility is worth something, and it is one of the main reasons to consider it alongside an advance.

Underwriting for factor rate products leans heavily on transaction data rather than on conventional credit scoring, which is why businesses with bad credit can sometimes still be funded, though usually at the expensive end of the range. The main inputs are the volume and consistency of your monthly card takings, how long you have been trading and processing cards, the size of the advance relative to your turnover, your sector, and whether the funder can see your settlement data directly because it already handles your payments.

One further point on regulation. An advance to a limited company is generally an unregulated commercial agreement, sitting outside the Financial Conduct Authority's consumer credit perimeter, so there is no requirement to quote an APR or produce standardised cost disclosure. Sole traders and some small partnerships may fall within the Consumer Credit Act depending on the size and purpose of the agreement. Either way, do not expect a comparable annual figure to be handed to you. Work it out.