Factor Rates vs. Interest Rates: How to Calculate the True Cost of Business Funding

One of the most confusing aspects of small business funding is that different products express their cost differently. Traditional loans use annual percentage rates (APR). Revenue-based financing uses factor rates. These two numbers are not directly comparable — and failing to understand the difference can lead you to make a costly mistake.

How Interest Rates Work

A traditional loan with an interest rate works like this: you borrow $100,000 at 12% APR for 2 years. You pay interest on the declining balance each month. As you pay down the principal, you pay less interest. Total cost depends on the term.

The key feature: interest accrues over time. The longer you hold the loan, the more interest you pay. Paying it off early saves you money.

How Factor Rates Work

A factor rate is a simple multiplier. You receive $100,000 at a factor rate of 1.3. You repay $130,000 total ($100,000 × 1.3 = $130,000). The $30,000 cost is fixed — it doesn't change based on how long repayment takes.

The key feature: the cost is predetermined. Unlike interest, it doesn't compound. Paying off early doesn't save you the full remaining "interest" — because there is no interest, just a fixed payback amount.

Why You Can't Compare Them Directly

A factor rate of 1.3 sounds lower than a 30% interest rate — but depending on the repayment timeline, it can be dramatically more expensive on an annualized basis.

Example:

• $100,000 at 1.3 factor rate, repaid over 12 months = $130,000 total = roughly 60% APR equivalent
• $100,000 at 1.3 factor rate, repaid over 6 months = $130,000 total = roughly 120% APR equivalent
• $100,000 at 12% interest rate over 2 years = roughly $113,000 total = 12% APR

The factor rate product costs significantly more on an annualized basis. That's the trade-off for speed and accessibility.

How to Calculate Effective APR from a Factor Rate

Simple formula: APR ≈ ((Factor Rate - 1) / Term in Years) × 2

This isn't perfectly precise but gives you a useful comparison number:

• 1.25 factor, 6-month term: (0.25 / 0.5) × 2 = 100% APR
• 1.25 factor, 12-month term: (0.25 / 1) × 2 = 50% APR
• 1.35 factor, 8-month term: (0.35 / 0.67) × 2 = 104% APR

When the Higher Cost Is Worth It

Revenue-based financing at a high effective APR can still be the right business decision if:

• The capital generates a return that exceeds the cost
• It's the only accessible option (credit or time in business precludes cheaper products)
• You need the money faster than any other product allows

A restaurant that borrows $40,000 at a 1.35 factor rate to purchase equipment that generates an additional $12,000/month in revenue has made a good financial decision — even at a high effective APR.

What to Ask Before You Sign

• What is the total payback amount?
• What is the daily or weekly payment?
• What is the estimated repayment term?
• Is there a prepayment discount?
• Are there any additional fees?

The Bottom Line

Know what you're paying and compare it honestly to what the capital will generate. HeyFunder will always show you the total cost in plain language before you sign anything. Apply in 5 minutes to see your options.