What is a Merchant Cash Advance Factor Rate and How Can I Calculate My Payments?
A merchant cash advance (MCA) or business cash advance can provide small business borrowers with an upfront fixed amount of cash in as little as 24 hours. The funding amount is based upon a percentage of the businesses credit card receivables or daily cash balances using historical credit card receipts and/or bank statements to determine the initial advance. The business pays back the advance, plus a percentage, often referred to as a discount factor, from a portion of their credit card receivables or cash available plus a percentage. The remittances are drawn from the business customer on a daily, or weekly basis until the obligation has been met. A merchant cash advance or business cash advance is not technically a business loan and as such, not limited in what rates they charge or what terms they establish. MCA's are good options for small business owners who may not have strong credit but have lots of credit card activity, or cash deposits and need financing quickly.
Conventional loans are the most common type of lending for small businesses, and what you would receive from a bank. They provide short-term, intermediate and long-term funding for businesses. Rates differ between each lender and depend on the overall credit risk of the business applying for the loan. The interest rates charged can either be fixed for the term of the loan at the time of closing, floating (for example the rate may fluctuate with the “prime rate”) or perhaps the loan will be fixed for a period of time and then float. A higher perceived risk will generally result in a higher interest rate. The monthly payment of conventional loans will generally include both interest and a principal reduction payment (commonly referred to as amortization). The amount of the payment is determined by the rate and term of the loan. Some loans are structured so that the monthly payments will completely repay the loan by the end of the term (also referred to as a self-amortizing loan) while other loans may be structured so that there is a balance remaining due at the end of the term (called a balloon payment). The latter will require the borrower to either refinance the loan at the end of the term or repay it from other available funds. Payment schedules, which are normally monthly, can be changed to quarterly and even annually if needed and agreed upon by both parties.
Most small business owners these days are not qualifying for traditional bank financing for one reason or another, and many of these businesses find alternative finance companies such as LVRG, providing daily debit or daily draw merchant cash advance products that are calculated using "factor rates." These are great small business funding options, if you need cash in a hurry. Unlike interest rates, which are expressed in percentages, factor rates are usually given in decimal figures. Factor rates usually vary from 1.2 to 1.5. The rate you get will depend on the length of time you’ve been in business, your industry, the average of your monthly sales, and the stability of those sales. Simply put, the higher the factor rate, the greater the risk.
You’ll need to calculate the total amount you need to repay in order to find the factor rate. Multiply the amount you need to borrow by the factor rate. For instance, If you’re borrowing $100,000 and the factor rate is 1.2, you’ll need to repay a total of $120,000. Taking that one step further, you then divide the total amount you owe, by the time in which you have to pay. Most merchant cash advances and cash flow type financing options are paid back daily, not including weekends or holidays; so you figure 21 days per month.
Let’s do some math here. If you borrow $100,000 with a 1.2 factor rate on a 12 month term; you multiply $100,000 X 1.2, which equals $120,000. That’s the total in which you will pay back over the course of the term - here is 12 months. You then divide $120,000 by 12 (months), giving you $10,000. $10,000 is how much you would be paying back on a monthly basis. Next you divide $10,000 by 21 days in the month (remember, we don’t include weekends or holidays) which comes out to $476 per day. So essentially, you will pay back $476 per day (21 days per month) for the next 12 months. When it ends, you would have paid back the full amount of $120,000.
You need to be aware that factor rates can make expensive loans appear cheaper. Also, you’re required to pay the interest up front, so paying off the loan early won’t save you interest charges. You may receive a discount off the total amount owed, if paid early and in full.
We can’t stress this enough: factor rates are not the same as interest rates. Factor rates are calculated only once using the original loan amount. Interest rates are calculated multiple times and are based on the depreciating capital.
Factor rates are different from APR financing, in that at the beginning of the life of the loan or advance, the lender calculates all of the interest due, and works it into your scheduled payments. With APR, financing interest accrues on the depreciating principal amount, so your interest payments get smaller and smaller as you make more payments.
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