Know What You Owe – Interest vs. Rate Factor
These days small and medium-sized businesses have many funding options at their disposal. From traditional term loans and lines of credit, to working capital advances and factoring loans, it’s hard to know how to compare each of these loan products. One surefire way is to compare the overall cost of funds.
Two of the most common cost metrics used are the Annual Percentage Rate (APR, or interest rate), and the Rate Factor, sometimes called a flat fee, or simple interest. We’ll assume a commercial business bank loan, and then a working capital advance for an amount of $100,000 for purposes of this comparison.
Interest Rate / APR – Commercial Bank Loan
Most folks are familiar with an APR; it’s used for home mortgages, auto loans, credit cards, commercial property and business loans.
- Loan Amount: $100,000
- Interest Rate (APR): 5.25%
- Loan Term: 10 Years
- Monthly Payment: $1,073
- Total Repayment: $128,750
Advantages: Repayment amortized over longer terms (smaller monthly payment); Usually secured, allowing for lower interest rates;
Disadvantages: Typically a slower process (several weeks to 6+ months); Business owner needs high personal credit score; Longer time in business required (2+ years); Longer loan term leads to higher total repayment.
Rate Factor – Working Capital Advance
Many business owners are less familiar with a Rate Factor, which is simply a flat fee charged on the funds borrowed.
- Advance Amount: $100,000
- Rate Factor: 1.25
- Term: 12 months
- Daily or Weekly Payment Options: $496.03 Each Business Day, or $2,480 Weekly
- Total Repayment: $125,000
Advantages: Quick processing time (1-3 business days); Unsecured; Personal credit not a primary factor; Minimal time in business required (6 months).
Disadvantages: Shorter terms; Higher relative APR (due to unsecured nature); Much more frequent remittances (daily or weekly)
Of course, there can be many other factors and/or metrics to consider as well while searching for the right type of funding for your business. In any case, make sure to properly vet any potential lending partners. Whomever you choose to work with should have prior experience arranging financing for businesses, should be knowledgeable regarding the different loan products that might be available given your company’s specific situation, and should be responsive to your requests.