The True Cost of Capital: APR vs Factor Rates
Understanding the real cost of business financing is crucial for making smart decisions. This guide breaks down the difference between APR and factor rates, and shows you how to calculate what a loan really costs.
What is APR?
Annual Percentage Rate (APR) is the yearly cost of borrowing money, expressed as a percentage. It includes interest plus any fees, giving you a standardized way to compare different loan products.
Example: A $50,000 loan at 15% APR over 2 years
Total interest paid: ~$8,000
Total repayment: ~$58,000
APR is typically used for traditional bank loans, SBA loans, and lines of credit. The longer your term, the more interest you pay over time—but your payments are lower.
What is a Factor Rate?
Factor rates are commonly used in merchant cash advances and short-term business funding. Instead of a percentage, it's expressed as a decimal multiplier (typically 1.1 to 1.5).
Example: $50,000 at a 1.3 factor rate
Total repayment: $50,000 × 1.3 = $65,000
Cost of capital: $15,000
Factor rates are fixed—unlike interest, they don't decrease if you pay off early (in most cases). This makes them more expensive for longer terms but predictable for budgeting.
The Hidden Cost Trap
A 1.25 factor rate might seem like "only 25%" but over a 6-month term, that's equivalent to approximately 50% APR. Here's how to convert:
Estimated APR = ((Factor Rate - 1) / Term in Years) × 100
1.25 factor, 6-month term:
((1.25 - 1) / 0.5) × 100 = 50% APR
This doesn't mean factor rate products are bad—they serve a purpose for quick capital needs. But you should understand what you're paying.
How to Make the Right Choice
- For long-term investments (equipment, expansion): Seek APR-based products with longer terms
- For short-term cash flow gaps: Factor rate products can make sense if you can repay quickly
- Always calculate the total cost in dollars, not just the rate or factor
- Ask about early payoff: Some products offer discounts, others don't