What is a factor rate?

The lender multiplies the principal by the quoted factor to produce a fixed total repayment. How quickly you repay that total, and whether repayments are daily, weekly, monthly or a percentage of receipts, determines the true cost and the impact on cashflow. Factors are usually quoted a little above 1, and go higher the shorter the term and the higher the risk.

Repayment styles vary: equal weekly or monthly instalments, fixed daily or weekly dollar amounts, a set percentage of card or bank receipts taken until the total is repaid, or hybrid and stepped payments. Lenders use factor rates because they are simple for borrowers with irregular income, they avoid complex amortisation disclosures when repayments are tied to sales, and they price credit risk and convenience rather than time-based interest.

A factor does not show the time value of money, so it needs converting before you can compare it with an interest-rate loan. For a quick approximation, divide the factor minus one by the term in years. That ignores the timing of repayments, so it can understate the true cost badly when payments are frequent.

The accurate method is to build the cashflow series: the principal as a negative amount at the start, then each repayment on its date, with establishment, merchant-processing and other fees included as costs. Solve for the internal rate of return per period (a spreadsheet RATE function for regular payments, XIRR for irregular ones) and annualise it as (1 + rate per period) to the power of periods per year, minus one. Shorter terms and more frequent repayments push the effective annualised cost up, because you are paying the full fee against a balance that falls quickly.

Ask for the full repayment schedule with dates and amounts, or a model of percentage-of-sales deductions, and for every fee in writing: establishment, monthly, merchant-processing, early repayment and default fees. Confirm whether the factor includes those fees, whether it is fixed or can rise after a late payment or default, and how it applies if you repay early or make extra payments. Ask the lender to show the annualised cost for the repayment frequency proposed. Where a broker or dealer arranges the facility, the buy rate is the wholesale factor the funder gives them, before any markup in the factor you are quoted.

Red flags include an advertised factor with no repayment schedule, a refusal to provide a written schedule or an annualised cost, unspecified processing or admin fees, default remedies that multiply the remaining balance, and contracts that let the lender change the percentage of sales or payment timing on its own. Early repayment does not always save money on a factor-rate facility, so get the effect in writing.