Factor rate vs APR: converting one into the other, and why it matters

A factor rate is a multiplier applied once. An APR is a rate applied over time to a declining balance. To turn one into the other you have to supply the missing ingredient, which is the length of the repayment period, and then account for the fact that you are repaying continuously rather than in a single lump at the end.

The rough version, good enough for a first pass, is this: take the total cost as a percentage of the advance, scale it up or down to a twelve month basis, then roughly double it. So a factor rate of 1.25 repaid over twelve months is a 25% total cost, which annualises to 25%, which is somewhere around 50% on an APR basis. The doubling is not arbitrary. It exists because you never have the full advance for the full term: by the halfway point you have already repaid about half of it, so the average balance you actually hold is roughly half the amount you were advanced.

The rest of this page is that calculation done properly, with the numbers set out so you can see what changes and what does not.

A factor rate is a total cost of capital figure expressed as a decimal. It answers the question how much will I repay in total, completely, on the day the agreement starts. Advance multiplied by factor rate equals total repayable; the difference is the cost. A 20,000 pound advance at a factor rate of 1.25 means 25,000 pounds repayable and 5,000 pounds of cost.

The number contains no reference to time, and that is not an oversight. On a merchant cash advance the funder buys an agreed quantity of your future card sales at a discount and recovers them through a holdback on each day's takings. Because the amount purchased is fixed and the delivery schedule is not, the price has to be fixed too. This is the whole logic of the product, and we set it out in more detail on our page explaining what a factor rate is.

What follows from that is important: a factor rate cannot get more expensive if things go slowly and cannot get cheaper if things go quickly. From the funder's side, a slow repayment is a worse return; from yours, it is better value. The factor rate is the same number in both cases.

An annual percentage rate is a standardised measure of the yearly cost of credit. It takes the interest, adds in compulsory fees that form part of the cost of the borrowing, and expresses the whole thing as a single annualised rate calculated against the balance outstanding at each point in the term. Because it is calculated on the declining balance, it reflects the reality that you stop paying for money once you have given it back.

Two properties of an APR matter here. First, it is a rate of use, not a quantity: a 20% APR on a facility held for two months costs far less in pounds than the same 20% APR held for two years. Second, it compounds. UK APR convention expresses the annual equivalent, so a monthly rate of 3.6% is not a 43% APR but roughly 53%, because the convention assumes the charge compounds across the year.

That standardisation is what makes APRs comparable across different products, which is exactly why regulated consumer lending is required to disclose one. It is also why the absence of an APR on a merchant cash advance leaves a real gap in the information available to a business owner making a decision.

There are four steps, and the third is the one that matters.

• One. Find the cost. Advance multiplied by the factor rate minus one. On 20,000 pounds at 1.25 the cost is 5,000 pounds.
• Two. Estimate the repayment period. Divide the total repayable by your expected monthly remittance. If the holdback is 10% of card takings and you take 40,000 pounds a month on cards, that is 4,000 pounds a month, so 25,000 pounds takes a little over six months.
• Three. Account for the declining balance. You do not hold the full 20,000 pounds for six months. You hold a shrinking amount that averages roughly half the advance. This is what turns a simple annualised figure into something comparable with an APR, and skipping it will understate the cost by roughly half.
• Four. Annualise and compound. Convert the per period rate to an annual equivalent.

Done precisely, step three and four together mean solving for the rate that makes the stream of repayments equal the advance, which is an internal rate of return calculation rather than something you can do on the back of an envelope. Our factor rate calculator will run it, and the tables below give you the answers for the most common cases.

The quick approximation, if you want one figure without a spreadsheet: total cost percentage, multiplied by twelve divided by the number of months, multiplied by two. For 1.25 over six months that gives 25 times two, times two, which is 100%. The precise answer is around 120%, so the approximation runs low, but it lands you in the right territory rather than out by an order of magnitude.

This table is the reason we think the conversion is worth doing at all. It takes one advance at one factor rate and changes nothing except how long the card takings take to clear it.

The pound cost never moves. The annualised price moves by a factor of eight. A business that trades strongly and clears the advance in four months has paid an APR equivalent of around 200% for the privilege; the same agreement, taken by a business whose takings are half as strong, is a 34% product. Neither of them negotiated a better deal. The difference is entirely trade.

This is also why we are cautious about the common advice to clear an advance as fast as possible. Unless your agreement carries an explicit early settlement discount, accelerating repayment does not save you a penny in cash and makes the money considerably more expensive per year of use.

Fix the term instead and you can see what the rate itself is worth. Here is a 10,000 pound advance repaid over twelve months across the usual range.

Note that the APR equivalent rises faster than the factor rate does. Moving from 1.1 to 1.2 doubles the cost in pounds and roughly doubles the APR equivalent, but moving from 1.4 to 1.5 adds only 25% to the pound cost while adding thirty points of APR equivalent. Compounding does that. It is a good reason to push hard on the rate at the top of the range even for what looks like a small improvement.

Plenty of comparisons stop at the middle column of our first table, the simple cost per year, and treat it as though it were an APR. It is not, and the gap is large enough to change decisions.

The problem is the balance. If you borrowed 20,000 pounds, held all of it for twelve months and then repaid 25,000 pounds in one payment, the annual cost really would be 25%. But that is not how an advance works. From day one the holdback starts taking money out of your card settlements, so by month six you are only using around half the original sum, and by month eleven you are using very little of it. Averaged across the term you have the benefit of roughly half the advance, while paying for all of it.

That is why the honest APR equivalent on a twelve month repayment of a 1.25 factor rate is roughly 53% rather than 25%. Both numbers are true statements about the same agreement. The first is the total cost of the money; the second is the price of the money you actually had. When you compare an advance against a bank facility, the bank's number is the second kind, so yours has to be too.

A merchant cash advance made to a limited company is generally not a credit agreement. The funder purchases a defined amount of future card receivables at a discount and recovers them through a holdback on settlements. Because there is no loan, there is no interest, and because there is no interest there is nothing for an annual percentage rate to describe in the statutory sense.

These agreements sit outside the Financial Conduct Authority's consumer credit perimeter and outside the Consumer Credit Act, so the disclosure rules that force a lender to publish a representative APR simply do not bite. Sole traders and some small partnerships can fall inside that perimeter depending on the size and purpose of the agreement, in which case additional protections and disclosure obligations may apply, and it is worth establishing which side of the line you are on before you sign.

None of this is a loophole in the pejorative sense. It is the ordinary position for commercial finance, and the same is broadly true of asset finance, invoice discounting and unregulated bridging. But the practical effect is real. Nobody in this transaction has a duty to hand you a comparable annual figure, and in our experience nobody volunteers one.

Because every alternative you might take instead is quoted that way. A bank term loan, an overdraft, a credit card, a revolving credit facility and most online business lenders all publish an annual rate. If you evaluate an advance on its factor rate and everything else on its APR, you will systematically flatter the advance, because the factor rate looks like a small number and the APR looks like a large one.

The comparison also disciplines the decision in a more useful way. An APR equivalent of 53% is not automatically a bad deal. Funding stock that turns three times a year at a healthy margin can carry that cost and still leave the business better off, and if the alternative is turning away trade, the arithmetic is easy. What the number does is force the question: what is this money going to earn, and is that more than 53%? That is a question a factor rate never prompts you to ask. We set out how the two products differ in structure on our page comparing a merchant cash advance with a business loan.

Having argued for the conversion, we should be straight about its limits. An APR equivalent assumes a repayment schedule, and a merchant cash advance does not have one. It has a holdback percentage and whatever your customers happen to spend.

That flexibility has genuine economic value that no annualised rate captures. If your takings halve in February, the remittance halves with them and nothing is in arrears. A fixed monthly loan repayment does not adjust, and a missed one is a default with consequences that follow your business and often your personal credit file. For a seasonal operation, a product that breathes with the trading cycle can be worth paying a premium for, and comparing it purely on APR equivalents will tell you it is irrational when it may be entirely sensible.

There is also the matter of what the alternative actually is. An APR you cannot obtain is not a comparison. If a business has been declined for bank funding, the honest comparison is between an advance at an equivalent of 60% and no funding at all, not between an advance and a 9% loan that exists in principle but not in practice.

Three numbers, three different jobs. Setting them out together makes it easier to see which one answers which question.

The fee row is worth pausing on. An APR is designed to sweep up compulsory charges, so a loan with a low headline interest rate and a large arrangement fee will show a higher APR than the interest rate alone suggests. A factor rate has no such convention. If a funder charges an arrangement fee on top of the factor rate, that cost sits outside the number entirely. A 2% arrangement fee on a 20,000 pound advance at 1.25 lifts the real cost from 5,000 pounds to 5,400 pounds, which is a 27% total cost rather than 25%, and it will push the APR equivalent up by several points. Always ask whether any fee is deducted from the advance or added to the total repayable, because the two are not the same.

Put the two products against each other on the same 20,000 pounds over the same twelve months and the gap is stark.

On cost alone the loan wins by a distance, and we would not dress that up. The advance is roughly four times more expensive in pounds for the same money over the same period. What the extra 3,650 pounds buys is the bottom row: a repayment that falls when trade falls, no fixed date by which a payment must be found, and in most cases a decision in days rather than weeks against card data rather than filed accounts.

Whether that is worth 3,650 pounds is a judgement about your own volatility and your own access to the alternative. For a business with steady revenue and a bank relationship, it usually is not. For a seasonal operator who would not get the loan anyway, the comparison is academic and the real question is whether the trade the money unlocks earns more than the cost of it.

Our answer is that the question is incomplete, because a factor rate on its own is not a price. But taking it at face value, most UK offers land between 1.18 and 1.35, and within that band the things that move the number are the consistency of your card takings, how long you have been trading, the size of the advance relative to turnover, and whether the funder can see your settlement data directly.

The better question is what combination of factor rate and holdback is good. A rate of 1.2 with a 20% holdback that clears in five months is an APR equivalent of well over 80%. A rate of 1.3 with an 8% holdback that clears in fourteen months is closer to 50%. The second deal has the worse headline and is the better price. Get both numbers, estimate the term, and compare the outputs rather than the inputs. Our page on merchant cash advance rates works through what to ask for on each quote, and the worked examples show what the arithmetic looks like on real trading patterns.