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Understanding Factor Rate and How it Determines Your Business Loan Repayment Plan

Understanding Factor Rate and How it Determines Your Business Loan Repayment Plan

Unlike personal loans and mortgages, equipment financing/leasing doesn’t account for an interest rate or APR. 

Instead, the amount of interest you’ll end up paying is calculated using a method called factor rate.

A factor rate — is essentially “interest”, but calculated at the outset of the loan and spread across your payments throughout the borrowing period.

This type of financing is beneficial for your businesses in two ways: 

First, because it allows you to pay a consistent, predictable payment for the entirety of your funding.

Second, factor rate loans typically come with fewer hoops and a faster approval process than other financing products available (and that means faster access to much-needed cash, too).

Still, borrowing funds as a business isn’t free, and as with any loan, you will pay a fee for borrowing the funds your business needs. 

But what exactly will you pay, though, and how is that amount determined? 

Well, that depends on several factors.

What Determines Factor Rates in Business Financing

Truck factor rate

As with an interest rate on a car or mortgage loan, your factor rate will depend on your risk to the lender — or your ability (and likelihood) to repay the loan, your organization’s financial stability, and other significant factors.

Generally, the more of a risk you are of not paying back your loan, the higher that factor rate will be. 

Here’s what lenders will usually consider when determining the factor rate on your business financing:

  • Your cash flow – The lender will look at your bank and credit card processing statements. They will also look at your recent tax returns to ensure you have consistent sales and steady cash flow. These are signs your business is financially healthy and should have no problem repaying the loan.
  • Your debts – If you have existing loans and mortgages, your lender will also want to see that you’ve been paying this on time, every time. This factor is one of the strongest indicators that you’re a safe bet as a borrower.
  • Your credit score – Your credit score will also play a role in the factor rate your loan receives (as will anyone else’s on the application). Though business loans don’t always require stellar credit, a higher score will often mean a lower factor rate and a lower cost to borrow on the whole. 
  • Your industry – Some industries are simply riskier than others. Businesses in industries that are seasonal or particularly volatile in sales volume will usually receive higher rates than those in steadier sectors. Some high-risk areas include retail, real estate, transportation, and construction. 
  • The amount of time you’ve been in business – Lenders want proof you’re a thriving, healthy business.  And that you’ll stay that way for as long as they loan you money. Because of this, longer-standing businesses will typically qualify for lower rates than newer organizations. 

The lender or financial institution you apply with will also play a role. Lenders with more experience or financial backing may be able to offer lower rates than smaller or newer operations can. 

Qualifying for a Lower Factor Rate

Plumbing equipment financing

There are several strategies you can use if you want to reduce the factor rate you’ll pay for business financing. For one, you can put off your application until you have a significant history as a business. Lenders generally want to see at least one year in business, at the bare minimum.

You might also work on improving your credit score if it’s not in a great place. 

Paying down your debts, settling any collections, and reporting any errors on your credit report can all give your score a boost. This will also help with your application.

Finally, opt for a shorter-term loan. A guarantee of repayment in a shorter amount of time will typically mean a lower cost to borrow. 

What Will You Pay for Your Business Loan?

If your company requires business financing, equipment loans, invoice factoring, or other funds, get in touch with First Capital today.

We’ll walk you through the costs your financing options, as well as what you can expect to pay for your loan. 

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