Understanding Factor Rate Lending vs Standard Loans

Factor rate lending is a mystery to most people. The first time you may have come across it is when you’ve perhaps looked at capital raising, plus several different loan deals and seen factor rates mentioned, which made you curious. 

In this article, we cover what a factor rate is and how it’s different from loans that charge interest. 

Money

What is a Factor Rate?

A factor rate is a multiplier on the original principal loan amount. With factor rates, they’re designed to compensate the lender by multiplying up the original amount borrowed by a certain fraction. 

For instance:

Loan: $1,000

Factor rate: 1.2

Repayment total: $1,200

As you can see, the original sum is multiplied, in this example, 1.2 times. The $1,200 becomes the total amount due and is then calculated to be repaid over the loan period with monthly repayments scheduled. 

How Does a Factor Rate Loan Differ from a Regular One?

With a standard interest-based loan, a loan is charged at an agreed rate daily. The interest is different at each stage of the loan because the remaining balance is on the decline as payments are received. Therefore, the interest is not a consistent amount each month. 

For factor rate lending, interest rates are not used. Instead, the loan principal is multiplied once by the factor rate. Factor rate lending is just a different approach to charging for lending money. 

Does It Have a Bearing on Early Repayment

For interest-rate loans, it’s usually possible to either accelerate payments or make a lump sum repayment to clear the remaining balance. Depending on the type of loan, it’s not uncommon to save some money on the interest by paying early. However, it’s not as much as expected because the majority of the interest is charged early on when the outstanding balance is the highest. 

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With factor rate loans, the full amount, including the factor rate multiplier, is due for repayment. There is no interest rate discount for paying earlier because the factor rate multiple is added at the initiation. However, sometimes a lender may offer a discount for early repayment of a factor rate loan and this is worth checking.

How Does a Lender Decide on the Appropriate Factor Rate?

Just like with other forms of lending, it’s necessary to examine the credit history to check whether making a loan offer makes sense.

The number of open credit lines and the purpose of the loan are just two considerations of many. Ultimately, factor rates are considered safer to lend on than interest-bearing loans, which is a positive for people wanting to get loan approval.

Which Type of Loan is Best?

It’s not a case of which is best. Depending on the purpose of the loan and other factors, or just the lender itself, one type or another type of loan may be offered. 

Certainly, for people who usually repay a loan over the full term and get a reasonable factor rate offer, factor rate lending isn’t necessarily more expensive than any other type of loan. 

Hopefully, this provides greater clarity and removes the mystery over factor rates and loans of this type.

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