Updated on September 30, 2020 Every time you apply for financing or to borrow money, you’ll notice an associated interest rate or factor rate. But what are the differences between these two rates and why does it matter for business owners? These numbers will look wildly different, but at their most basic level, factor rates and interest rates are both numerical signifiers of how much you’re going to pay in order to borrow money. Maybe the best way to understand what makes these rate signifiers different is to understand them each individually. We’re going to break it all down for you and explain what makes factor rates and interest rates different and why every business owner should care.

## What’s the difference?

If asked about their preferences, most business owners say they would prefer a loan that includes an interest rate over one that features a factor rate. But that either-or choice is deceptively simple. The total repayment amount for financing with a factor rate is calculated in advance based on the original funding amount. Meanwhile, the total repayment amount for loans with interest rates will change depending on how quickly repayment is made. Total cost of the loan calculated at the beginning (factor rate) versus the end (interest rate) is a simple difference, but it’s incredibly important.

### Factor Rate Pros

• The principal and the factor rate are both known from the start of financing and the values will not change. This may make it easier for businesses to set regular payments.
• Financing that comes with factor rates is often faster to access than that which comes with an interest rate.

### Factor Rate Cons

• May have higher base when compared to interest rates.
• There are no incentives built in for early payment of financing. To decrease the total cost of financing through early payment a merchant would need to contact their financier and make a request.
• Financing with factor rates often offers less time for the recipient to pay back the funds.

### Interest Rate Pros

• May have a lower base when compared to factor rates.
• Interest rate loans may provide more time, or a longer term, to repay the loan.
• Early payment is rewarded with decreased loan duration and therefore less money paid on interest.

For example, if \$12,000 of financing is subject to an additional \$3,000 in factor rate expenses, you know the total cost of financing is \$15,000. However, for an interest rate bearing loan, if you find yourself unable to meet the schedule of monthly payments that have been predetermined, the interest charges that have already been racked up will be included in the next charge. In effect, if you miss a payment or can only make a partial payment one month, you could end up getting charged a whole lot more than you expect. Your expected \$3,000 payment could become \$3,500 or \$4,000. Instead of \$15,000 you may pay \$15,500, \$16,000 or more if you fall behind on payments.

## Is Interest Rate or Factor Rate Better for Small Business Loans?

The greatest factors in determining which type of financing is best for your small business are creditworthiness and time, or how soon your business needs funding. Financing with factor rates, using products like a Merchant Cash Advance (MCA), will benefit those who need money faster or who have a less favorable credit history.  This type of financing also has the benefit of being more predictable than loans, as the total amount owed is set as soon as the financing is originated.

### Factor rate financing may be a fit for your business if:

• You need funding fast (within days) as opposed to later (several weeks).
• You like the idea of making steady, static payments.
• You prefer to pay down the funding debt faster.

In contrast interest rate loans can be strong options for businesses that have a little more time before they need the funds or have a more beneficial credit history.

### Interest rate loan may be a fit for your business if:

• You prefer a longer repayment period and lower payment amounts.
• You like the incentive of decreased interest owed for early payment.
• You have been in business for two or more years.
• You believe you will make payments on time, if not early.