Talk to any funder about business financing and you'll hear two terms thrown around interchangeably: factor rate and interest rate. They sound similar. They're not.
This is one of the most misunderstood — and most expensive to misunderstand — concepts in small business funding. A 1.3 factor rate doesn't mean 30% interest. And an "APR" comparison can hide the real cost of a merchant cash advance.
This guide breaks down the exact difference in plain English, shows you how to calculate the true cost of each, and gives you the math to compare offers apples-to-apples.
TL;DR: An interest rate is a percentage charged on the remaining balance of a loan — it compounds over time and decreases as you pay down principal. A factor rate is a flat multiplier applied to the entire advance amount — it does not compound, and the total cost is fixed from day one. A 1.25 factor rate on $100,000 means you repay $125,000, period. To compare offers fairly, calculate the total payback for each and divide by the term. Berkman Financial shows total payback, factor rate, and daily payment on every offer — no math required.
What is an interest rate?
An interest rate is the percentage a lender charges on the outstanding balance of a loan, calculated over time. It is the standard pricing model for traditional bank loans, SBA loans, and business lines of credit.
Here is how it works in practice: if you borrow $100,000 at 10% annual interest over two years, you pay interest on the declining balance. In month one, your interest is calculated on $100,000. By month twelve, you have paid down principal, so interest is calculated on the remaining balance — say $55,000. The total interest you pay over the life of the loan depends on the amortization schedule.
Key characteristics of interest rates:
- Compounds over time — you pay interest on the remaining balance, which decreases as you make payments
- Expressed as an annual percentage (APR) — makes it straightforward to compare loans from different lenders
- Total cost depends on repayment duration — pay faster, pay less total interest
- Standard in traditional lending — banks, SBA lenders, and credit unions all use interest rates
Interest rates are regulated and standardized. The Truth in Lending Act (TILA) requires lenders to disclose APR, making it relatively easy to compare offers.
What is a factor rate?
A factor rate is a flat decimal multiplier applied to the total advance amount. It is the pricing model used for merchant cash advances and some revenue-based funding products.
Here is how it works: if you receive a $100,000 advance at a 1.25 factor rate, you repay $100,000 x 1.25 = $125,000 total. The $25,000 is the cost of capital. That number is fixed from the moment you sign — it does not change regardless of how quickly or slowly you repay.
Key characteristics of factor rates:
- Does not compound — the total repayment amount is fixed on day one
- Expressed as a decimal (1.15, 1.25, 1.35) — not as a percentage
- Total cost does NOT change with repayment speed — whether you repay in 4 months or 12, you owe the same total (unless your funder offers an early-payoff discount)
- Standard in alternative funding — MCAs and some revenue-based products use factor rates
Factor rates are simple to understand once you know what they are. The confusion comes when people try to compare them directly to interest rates without converting.
Factor rate vs. interest rate: the key differences
| Feature | Factor Rate | Interest Rate |
|---|---|---|
| How cost is calculated | Multiplier on total advance | Percentage on declining balance |
| Compounding | No — flat cost, fixed from day one | Yes — interest accrues on remaining balance |
| Total cost certainty | Known immediately | Depends on repayment schedule |
| Effect of early repayment | Usually no savings (unless discount offered) | Saves money — less time = less interest |
| Where it's used | MCAs, revenue-based funding | Bank loans, SBA loans, lines of credit |
| Regulated by TILA | No | Yes |
| Easy to compare across offers | Yes (just multiply) | Yes (use APR) |
The fundamental difference: with an interest rate, paying faster saves you money. With a factor rate, paying faster does NOT save you money unless the funder specifically offers an early-payoff discount. This is critical to understand when comparing offers.
How to calculate the total cost of a factor rate
The math is simple:
Advance amount x factor rate = total repayment
Examples:
| Advance | Factor Rate | Total Repayment | Cost of Capital |
|---|---|---|---|
| $50,000 | 1.15 | $57,500 | $7,500 |
| $50,000 | 1.25 | $62,500 | $12,500 |
| $50,000 | 1.35 | $67,500 | $17,500 |
| $100,000 | 1.20 | $120,000 | $20,000 |
| $200,000 | 1.30 | $260,000 | $60,000 |
That is the entire calculation. No amortization tables, no compounding formulas, no variable rates. The total you owe is locked the day you sign.
Example: $50K funding compared using both methods
Let us compare two real offers for $50,000 in business funding:
Offer A: Bank term loan at 12% APR, 12-month term
- Monthly payment: approximately $4,442
- Total repayment: approximately $53,300
- Total cost of capital: approximately $3,300
Offer B: Merchant cash advance at 1.25 factor rate, ~8-month repayment
- Daily payment: approximately $390 (based on 10% holdback of daily revenue)
- Total repayment: $62,500
- Total cost of capital: $12,500
The bank loan costs $3,300. The MCA costs $12,500. The MCA is nearly four times more expensive in raw cost.
So why would anyone choose the MCA? Three reasons:
- The bank loan takes 3 to 6 weeks to approve. The MCA funds today.
- The bank loan requires 680+ credit, collateral, and extensive documentation. The MCA requires bank statements and approves credit scores from 500+.
- The bank loan has fixed monthly payments regardless of revenue. The MCA adjusts daily with your sales volume.
The "right" choice depends on your situation. If you qualify for the bank loan and can wait, take it. If you cannot qualify or cannot wait, the MCA solves the problem at a higher price — and for many businesses, that trade-off makes sense.
Why merchant cash advances use factor rates instead of interest rates
Merchant cash advances are not loans. They are a purchase of future receivables. This legal distinction matters for several reasons:
- MCAs are not subject to usury laws in most states, because they are not classified as lending
- MCAs are not required to disclose APR under the Truth in Lending Act, because TILA applies to loans
- Factor rates are simpler for a product where repayment duration is variable (it depends on how fast your sales come in)
Because the repayment term on an MCA is not fixed — it depends on your daily sales volume — a traditional APR calculation does not apply cleanly. A factor rate gives both the funder and the business owner a clear, fixed total cost regardless of how long repayment takes.
This is also why comparing an MCA factor rate to a bank loan APR directly is misleading. They measure different things.
Should you care about APR when comparing offers?
Yes and no.
APR is useful when comparing offers that are structured the same way — two bank loans, two SBA loans, or two lines of credit. It standardizes the cost over a year, making apples-to-apples comparison easy.
APR is less useful — and can be misleading — when comparing a bank loan to a merchant cash advance. Because MCA repayment duration is variable (driven by your daily sales), the "annualized" rate can look astronomically high even when the total dollar cost is moderate and known in advance.
What you should focus on instead:
- Total repayment amount — how many dollars are coming out of your business?
- Daily or monthly payment — can your cash flow handle it?
- Repayment timeline — how long will you be paying?
- Early payoff terms — can you save by paying faster?
Every offer from Berkman Financial's funder network shows these four numbers clearly — whether it is a factor-rate product or an interest-rate product. No conversion needed, no hidden math.
How to compare funding offers honestly
When you receive multiple offers — especially a mix of factor rate and interest rate products — use this framework:
- Write down the total payback for each offer. This is the single most important number.
- Write down the daily or monthly payment. Can your business handle this alongside normal operations?
- Calculate the cost per dollar funded. Divide total cost of capital by the advance amount. A $12,500 cost on a $50,000 advance = $0.25 per dollar funded. A $3,300 cost on a $50,000 loan = $0.066 per dollar funded.
- Factor in speed. If you need money today, a cheaper product that takes 6 weeks is not actually available to you.
- Factor in qualification. If you do not qualify for the bank loan, it is not an option — regardless of price.
A business loan broker does this comparison for you. When you apply through Berkman, your advisor presents competing offers with all of these numbers side by side — factor rate products and interest rate products on the same page.
Compare your options — apply in 5 minutes
Common questions about factor rates and interest rates
Is a factor rate the same as an interest rate?
No. A factor rate is a flat multiplier applied to the total advance amount — the cost is fixed and does not compound. An interest rate is a percentage charged on the declining balance of a loan — it compounds over time. A 1.25 factor rate on $100,000 means you repay $125,000 total. A 25% APR on $100,000 means something very different depending on the repayment schedule.
How do I convert a factor rate to an APR?
The rough formula is: [(factor rate - 1) / repayment term in years] x 100 = approximate APR. For example, a 1.25 factor rate repaid over 6 months: [(1.25 - 1) / 0.5] x 100 = 50% approximate APR. But this is an estimate — APR assumes declining-balance interest, and factor rates do not work that way. Use total payback as your comparison metric instead.
What's a typical factor rate for a merchant cash advance?
Factor rates for merchant cash advances typically range from 1.15 to 1.35. A 1.15 factor rate means you repay $1.15 for every $1.00 advanced. A 1.35 factor rate means $1.35 per $1.00. Your rate depends on revenue, time in business, industry, and repayment history with previous advances.
Are factor rates more expensive than interest rates?
In raw dollar terms, factor-rate products usually cost more than traditional interest-rate loans for the same funding amount. The tradeoff is that factor-rate products fund faster, require less documentation, approve lower credit scores, and have flexible repayment tied to daily sales. The cost premium pays for speed and accessibility.
Which type of business funding uses factor rates?
Merchant cash advances and some revenue-based funding products use factor rates. Bank term loans, SBA loans, business lines of credit, and most equipment financing use interest rates. When comparing offers across both categories, focus on total capital cost and daily payment impact rather than trying to convert between the two systems.
