If you own a small business, then you likely know that having access to capital quickly can be the difference between keeping your doors open and having to find another line of work. Merchant cash loans and merchant cash advances have helped a lot of entrepreneurs stay open, particularly those entrepreneurs whose companies that have not had a lot of luck getting credit from banks.
Most merchant cash advances are short-term, between three months and a year, with payments going in daily. Most commonly, these payments come out of daily credit card receipts at a set percentage, or regular withdrawals from the company’s checking account. The benefit of this type of loan is that a business can get access to money quickly without having to deal with the onerous documentation requirements and approval metrics that traditional lenders use when determining loan approval.
It is true that merchant cash advances are a little pricey to pay back. A lot of independent analysts are reporting that the loans carry an effective interest rate between 18 and 50%. However, there are some things to consider before you run away from this sort of financing because of the sticker shock.
It is important, though, to look at how these loans work and provide an apples-to-apples comparison between the way a merchant cash advance works and the way that other traditional vehicles of credit are both priced and presented.
For example, when you take out a mortgage or open up a credit card, or take out a loan for your new car or for your next semester at college, the interest rate appears as an annualized percentage rate, or APR. A merchant cash advance is priced with what is known as the factor rate, or the buy rate. Buy rates and APRs work a little differently in several ways that make comparing them a little tricky.
Example of merchant cash advance
Take a look at this example. When you take out a merchant cash advantage, you’re likely to see a buy rate, or a factor rate, somewhere between 1.1 and 1.5. You use this to figure out how much you will have to pay back. So if you are looking at a $50,000 advance with a 1.25 factor rate for a 12-month note, you will have to pay back $62,500. Now, does that sound like a 25% interest rate? Yes, and it is true that the loan costs you 25% in interest ($12,500). However, when you take out a merchant cash advance, all that interest gets charged to the principal at origination. With an APR loan, the interest is charged to the loan over time, so if the APR is 25%, you end up paying back less – because you’re not paying as much for the cost of borrowing. So your effective APR is going to be higher than that cost of taking out the money.
It’s also important to look at the term. If you have a 1.25 factor rate for that $50,000 advance, but your term is only six months, you still have to pay back $62,500, but you have to do it twice as quickly, which means that your effective interest rate on that money is even higher.
If you have questions about your own business, get in touch with Amansad Financial. Merchant cash advances are not the best answer for every entrepreneur, and we will have an underwriter go over your situation and develop a recommendation for your business.