How To Calculate Rates On A MCA

INTEREST RATES VERSUS FACTOR RATES

Interest Rates

Most business owners are knowledgeable regarding the term” interest rate”. Many have calculated interest rates associated with a credit card or a mortgage.

Interest is essentially the amount of money you pay to use someone else’s money, calculated over time. Interest rates are expressed by a percentage and you can normally pick up a calculator to compute how much you would pay to utilize borrowed money over a particular period of time.

For example, with 20% interest on a $100.00 loan, you would pay back $120.00.

Factor Rates

Merchant cash advances do not use a typical interest rate to calculate the use of funds. They use what is called a “factor rate”.

A factor rate also calculates how much you will pay for money that is borrowed, but it is expressed as a decimal figure or a multiple. The calculation may be noted as a 1.2 or 1.5 factor. Factor rates typically range between 1.2 to 1.5. Basically, that is designed to suggest that you will pay back 120% or 150% of the money you borrowed.

When using interest rates, the rates will be recalculated over the term of the loan as long as payments are made. A factor rate is calculated at the beginning of the loan and never changes.

For example, if you received a $65,000.00 merchant cash advance at a 1.30 factor rate, you would multiply $65,000.00 X 1.30 = $84,500.00. This means the cost of the advance is $19,500.00.

Being that you and most business owners are accustomed to using percentage rates, we will guide you how to convert a factor rate to an annualized percentage rate (APR).

TURNING THE FACTOR RATE TO ANNUALIZED PERCENTAGE RATE (APR)

Below we will compare an interest rate on a standard loan to a factor rate with a merchant cash advance.

For the example, we will use a $40,000.00 merchant cash advance at a 1.3 factor rate with a repayment period of 180 days.

Step 1: Compute the Total Cost of the Merchant Cash Advance

This step will help us figure out the total amount of money you will need to pay back to the lender based upon the factor rate. In this step, you multiply the amount you are being loaned by the factor rate to get the total amount. The formula looks like this:

The amount of the advance (X) The factor rate = total cost of the merchant cash advance Using our example of a $40,000.00 advance, we can calculate the following: $40,000.00 X 1.3 = $52,000.00

Step 2: Compute the Actual Cost of the Merchant Cash Advance

Now we will calculate the amount of money you will be paying back beyond the amount loaned to you. The formula to do so looks like this:

Total cost of the merchant cash advance (-) the amount loaned to you = actual cost Example: $52,000.00 – $40,000.00 = $12,000.00

Step 3: Compute the Percentage Cost of the Advance

Use the following formula:

Actual Cost of the merchant cash advance (/) by the principal amount = percentage cost Example: $12,000.00 / $40,000.00 = 0.3

Step 4: Compute the Annualized Interest Rate

First we will get the rate over the course of a year using this formula:

Percentage cost multiplied by 365 (every day in the year) = x .3 x 365 = 109.5 We will then divide that number by the number of days in the repayment period to get the Annualized Interest Rate. x / the expected repayment period (in days) = Annualized Interest Rate 109.5 / 180 = .6083 or 60.83%

What this means in the example above is that if you were to borrow $40,000.00 in the form of a merchant cash advance, you will be paying a 60.83% annualized interest rate for the use of that money.

HOW IS THE FACTOR RATE DETERMINED?

If you are a savvy business owner and you are interested in the true cost you are going to pay for your advance, you need to learn what controls the calculation of a merchant cash advance factor rate. So, what does determine your factor rate?

1. Average Monthly Credit Card Sales – You will be asked to supply 3 months business bank statements to prove that you will be able to pay back the advance proposed to you. If the funder sees strong sales, demonstrating that it is highly likely that you will be able to pay the advance back, your factor rate will be lower.

2. Length of Time in Business – Many merchant cash advance lenders require you to be in business for at least 12 months. There are some that only require as little as 3 months. The longer you have been in business, the more likely you will be able to continue doing business and pay back any proposed advances. The longer you have been in business, the better the factor rate you will be offered.

3. Business Industry – There is much more risk associated with certain types of businesses. This plays a vital role in the rate that you may be charged. The more risky or volatile the industry, the higher the factor rate.

4. Personal Credit History – Many merchant cash advance funders will pull your personal credit history in order to gauge how responsible you are regarding repaying your debts. Lower credit scores will usually raise your factor rate. Higher credit scores may lower your factor rate.