How to Compare Business Loan Offers: APR, Factor Rates and Total Cost

Two business owners can each be told "your cost is low" and be paying completely different amounts. That is because the industry quotes price in at least three ways:

• Interest rate, such as 12 percent a year, charged on the balance you still owe.
• Factor rate, such as 1.25, a multiplier applied once to the amount funded.
• Fees, such as an origination fee deducted from your proceeds.

Until all three are converted into dollars and then into an annual percentage rate (APR), you cannot tell which offer is cheaper.

With a conventional term loan, interest accrues on the declining balance. As you pay the principal down, you owe less interest.

Example: a $50,000 loan at 12 percent over 36 months has a monthly payment of about $1,660.72. Over three years you repay roughly $59,786, so the cost of borrowing is about $9,786. Because there are no fees in this example, the APR equals the 12 percent rate.

Now add a 5 percent origination fee taken from the proceeds. You still repay the same $59,786, but you only receive $47,500. Measured against the money you actually got, the APR rises to about 15.6 percent. Same quoted rate, noticeably higher true cost.

A factor rate is typically used for merchant cash advances and some short-term products. You multiply the amount funded by the factor to get the total payback, and the cost is fixed at that moment.

Example: $50,000 at a 1.25 factor means you repay $62,500, a cost of $12,500.

Here is what that cost looks like as an annual rate, assuming equal monthly payments:

• Repaid over 12 months: an APR of roughly 43 percent
• Repaid over 6 months: an APR of roughly 81 percent

The dollar cost never changed. What changed is how quickly you paid it back, and a shorter term squeezes the same cost into a smaller window. This is why a factor rate that sounds modest can be expensive. For a closer look at the product itself, read what a merchant cash advance is.

Use the same five questions for every offer, then fill in one line per lender:

1. How much will I receive after fees are deducted?
2. How much will I repay in total, in dollars?
3. What is the payment schedule: daily, weekly or monthly, and how large is each payment?
4. What is the APR, and does it include all fees? Ask the lender to state it.
5. What happens if I pay early? Is there a prepayment penalty, or is the full cost still due?

Then compare the total repayment ÷ amount received across offers of similar length. The smallest ratio is the cheapest money, all else equal.

The cheapest offer is not always the right one. Weigh these as well:

• Payment frequency. Daily or weekly debits can strain cash flow even when the total cost looks fine. Check the payments against your slowest week, not your average one.
• Speed. A slightly more expensive product that funds in two days may beat a cheaper one that takes six weeks if you are covering a time-sensitive opportunity.
• Security and guarantees. Collateral, UCC liens and personal guarantees change your risk, not just your price.
• Flexibility. A line of credit charges interest only on what you draw, which can make it cheaper than a lump sum you do not fully use.

Our business loan calculator can help you test different amounts and terms.

Slow down if a lender:

• Will not state the total repayment amount in writing
• Quotes only a factor rate or "cents on the dollar" and avoids discussing APR
• Pressures you to sign the same day
• Cannot explain fees that are deducted from your proceeds
• Offers terms that differ from what was discussed verbally

Reputable lenders and brokers explain the full cost and give you time to review it. If you would like a second set of eyes on an offer, a lendfloCapital advisor can walk through it with you. We are a broker, so we compare options across our lender network rather than selling a single product.