Running a business can be challenging. At times, cash flow may fall short right when you need it most. That’s where a merchant cash advance (MCA) comes in—a quick solution that can help you get back on your feet. However, before you go into what seems like an easy solution, you should understand the hidden cost of this financing.
The merchant cash advance factor rate might seem straightforward, but it can come with a significant cost if you’re not sure how to calculate it. That’s where we come in—to help you navigate the fine print and make sure you’re making informed decisions that protect your bottom line.
Value Capital Funding has worked with countless businesses facing MCA challenges. We know the frustration of watching daily sales disappear into loan repayments that seem never-ending. That’s why we’re here to help you decode the real cost of MCAs and provide a path forward if you feel like you’re stuck in a financial bind.
Unlike traditional loans that use interest rates, MCAs rely on factor rates. If you’ve looked at your MCA agreement and felt like you were reading a foreign language, you’re not alone. Many business owners struggle to grasp how a factor rate differs from interest rates they’ve encountered before. The factor rate is a decimal figure—usually between 1.1 and 1.5. This represents the total cost you’ll pay back for the advance. Unlike interest rates that fluctuate over time, a factor rate stays fixed throughout the life of your MCA.
For example, if you borrow $100,000 at a factor rate of 1.3, you’ll be required to pay back $130,000. That’s $30,000 above the original advance. The difference may seem straightforward. However, the true cost, including additional fees and the way repayments are structured often takes business owners by surprise.
Factor rates can be deceptive. Unlike a traditional loan, where you’re aware of your Annual Percentage Rate (APR), MCA agreements don’t typically disclose the true cost in APR terms. This lack of transparency means businesses often underestimate how much they’ll end up paying.
The repayment structure adds another layer of difficulty. Since payments are taken as a percentage of your daily sales, slow days might feel like a relief. Booming business means larger chunks of your revenue get diverted to repayment.
Let’s break it down. If you borrow $100,000 at a factor rate of 1.25, you’ll pay back $125,000. However, the real question is: how long will it take you to pay it back? The repayment period directly affects your effective APR. Paying it back over six months will significantly increase your borrowing costs compared to a longer term. On top of that, MCA providers often tack on additional fees which further inflate the total cost.
To uncover the true cost of your MCA, you need to convert the factor rate into an APR. Here’s how it works: multiply your advance amount by the factor rate to get your total repayment. Subtract the original advance amount from this total to determine the fees you’re paying. Then, factor in the length of your repayment period to see what percentage of your advance is eaten up by fees each year.
Consider this scenario: you borrow $100,000 at a factor rate of 1.25 with a six-month repayment window. You’ll pay back $125,000. This means your fees are $25,000.
When you calculate the annualized cost, you could be looking at an APR of 50% or more, which is a lot higher than the seemingly manageable factor rate of 1.25. And that’s before considering any hidden fees that might be tucked away in your agreement.
When businesses turn to MCAs, it’s often in moments of financial stress. With the repayment tied to daily sales, a few good weeks can accelerate your repayments and leave you short on cash when you need it most. Worse, some MCA agreements contain clauses that penalize early repayment which locks you into higher costs.
Many business owners also fail to realize that the shorter the repayment period, the higher the effective APR. A six-month repayment on a $100,000 advance at a 1.25-factor rate could result in a very high APR. In some cases, it can exceed 100% which rivals high-interest credit cards. If your MCA payments are draining your cash flow, our MCA debt restructuring options can help spread out your payments.
Don’t let a merchant cash advance dictate your business’s future. If you need MCA debt relief, MCA debt consolidation, or MCA debt refinancing, our solutions at Value Capital Funding help get your business back on solid ground. Contact us to explore how we can help you take the first step toward financial relief.