Factor rate to interest rate: what a short-term business loan really costs

A factor rate tells you the total amount you repay as a multiple of the amount borrowed: a factor of 1.25 on $50,000 means you repay $62,500. It is not an annual interest rate, and because short-term loans are repaid over months with daily or weekly payments, the equivalent annual cost is far higher than the factor suggests. In the main example below, a 1.25 factor over nine months works out to an effective annual cost of about 57%, not 25%. Convert every factor-rate offer before comparing it with a bank loan.

This guide is part of the business loan application checklist. Figures are illustrative.

Why a factor rate looks cheaper than it is

Three things make the factor misleading on its own:

1. It is not annual. A 25% charge over nine months is already more than 25% a year.
2. The balance falls from the first payment. With daily or weekly repayments, you have the full amount for only a few days, and on average roughly half of it across the term. You pay the full charge on money you are steadily handing back.
3. The charge is fixed. Unlike interest, which falls as the balance falls, the factor charge does not shrink if you repay early, unless the contract gives a discount.

Worked example 1: $50,000 at a 1.25 factor over nine months

• Amount advanced: $50,000
• Total to repay: $50,000 × 1.25 = $62,500
• Cost: $12,500
• Repayments: roughly 189 business-day debits of about $331 (equivalent to about $6,944 a month)

Naive calculations:

• "25% of the loan" — true for the whole term, but not an annual figure.
• Simple annualising: 25% ÷ 0.75 years = 33% — still too low, because it ignores the falling balance.

Correct approach: find the interest rate at which nine monthly payments of $6,944 repay $50,000. Solving that (with a spreadsheet RATE function, or a financial calculator) gives a monthly rate of about 4.7%, which is about 57% a year expressed as a nominal annual rate. Daily repayments make it slightly higher again.

Worked example 2: the same factor, faster repayment

If the same $62,500 had to be repaid over six months ($10,417 a month), the effective annual cost rises to about 81%. Shorter terms make the same factor more expensive.

Worked example 3: adding an origination fee

Suppose the lender also deducts a 2.5% fee ($1,250), so you receive $48,750 but still repay $62,500 over nine months. The effective annual cost rises to about 63%. Use the net proceeds calculator to find the cash received before you do the conversion.

Quick conversion table

Nominal annual equivalent for illustrative factors, assuming equal monthly repayments and no fees:

Daily or weekly repayments, deducted fees and broker fees push these higher. Treat the table as a rough guide and calculate each offer.

Merchant cash advances and revenue-based repayments

A merchant cash advance (MCA) is repaid by taking a fixed percentage of your card takings each day until the agreed total is repaid. The factor is fixed, but the term is not:

• If sales are strong, you repay faster and the effective annual cost rises.
• If sales are weak, repayment slows and the annual cost falls, but less cash reaches your account when you can least afford it.

Check whether the contract has a minimum payment, a deadline by which the total must be repaid, or default triggers if sales fall.

When a high-cost short loan might still make sense

There are narrow cases where it can be rational:

• a short, certain gap, such as a confirmed contract payment due within weeks, where the dollar cost is small relative to the profit at stake;
• a one-off opportunity with a clear return, such as a discounted stock purchase that will sell quickly.

It rarely makes sense for paying ongoing wages, tax debts or other loans, or for long-term assets. Using one high-cost short loan to pay another is a common path to a debt spiral. See business loan mistakes to avoid.

Checklist before accepting a factor-rate offer

• Total repayable in dollars, and cash you will actually receive
• Repayment frequency (daily, weekly) and amount
• Effective annual cost, calculated as above
• Early repayment terms: is any of the charge refunded?
• Security, guarantees and any GSA registration
• What happens if a direct debit fails
• Whether a cheaper option exists: overdraft, invoice finance or a bank term loan (compare in the three-offer example)

Related guides

Short-term lenders often deduct fees as well; the low-doc guide explains what they assess, and the refinancing example shows when moving to a cheaper loan pays off.

Frequently asked questions

Is a factor rate legal in Australia?

Yes. Business credit is generally outside the National Credit Code, so there is no consumer-style cap or required comparison rate. Misleading statements about cost and unfair contract terms can still breach the ASIC Act.

Is a factor rate the same as a flat rate?

They are similar ideas: both charge on the original amount regardless of the falling balance. A flat rate is usually quoted per year; a factor is for the whole term.

Does repaying early save money?

Only if the contract provides a discount. Many factor-rate products require the full charge regardless.

Can I complain if the cost was not explained?

You can raise it with the lender and, if it is an AFCA member and you are eligible, with AFCA. See complaints and official sources.

Sources

• ASIC — misleading conduct and unfair contract terms in financial products
• ASIC Moneysmart — understanding interest and loan costs
• business.gov.au — business finance options
• Australian Financial Complaints Authority — disputes with lenders