Quick Biz Capital Blog

Factor Rates vs Interest Rates: What Business Owners Need to Know

One of the most confusing aspects of business financing is the difference between factor rates and interest rates. Banks use interest rates. Alternative lenders often use factor rates. Understanding the difference is critical to comparing offers and finding the best deal.

What Is an Interest Rate

An interest rate is a percentage charged on the outstanding balance of a loan, calculated annually (APR). As you pay down the principal, the interest amount decreases. A $100,000 loan at 10% APR over 12 months costs about $5,500 in total interest. Interest rates are the standard in traditional banking and make it easy to compare across products.

What Is a Factor Rate

A factor rate is a decimal number (like 1.2, 1.3, or 1.4) multiplied by the total advance amount to determine your payback amount. A $100,000 advance at a 1.3 factor rate means you repay $130,000 regardless of how quickly you pay it back. The cost is fixed at the beginning and does not decrease as you pay down the balance.

Why the Difference Matters

Here is the key difference: with an interest rate, paying early saves you money because you are charged interest on the declining balance. With a factor rate, the total cost is locked in upfront. Paying a factor rate loan back in 6 months versus 12 months does not save you anything in total cost, but it dramatically changes the effective APR.

How to Convert Factor Rate to APR

To roughly compare a factor rate to an APR: take the factor rate cost divided by the loan amount, divided by the term in years, times 100. A 1.3 factor rate on a 12-month advance is roughly equivalent to a 30% APR. A 1.3 factor rate on a 6-month advance is roughly equivalent to 60% APR. This is why term length matters so much.

Which Is Better

Neither is inherently better. Interest rates are more transparent and reward early repayment. Factor rates are simpler to understand upfront and are standard in the MCA and revenue based financing space. The key is converting both to total cost of capital so you can compare apples to apples.