Rates & Costs · 6 min read
Factor rate vs interest rate: understanding what your business loan actually costs
Most Australian business owners know what an interest rate is. Far fewer understand factor rates — and that gap can be expensive.
What is an interest rate?
An interest rate is the annual cost of borrowing expressed as a percentage of the outstanding balance. It's calculated on the amount you still owe, which decreases as you repay.
For example: a $100,000 loan at 18% p.a. over 24 months. In month one, you're paying interest on $100,000. By month 12, you're paying interest on roughly $50,000. The total interest decreases over time. This is called a “reducing balance” or “simple interest” structure.
What is a factor rate?
A factor rate is a multiplier applied to the total amount borrowed. It does not reduce as you repay. The cost is fixed upfront and added to your total repayment obligation from day one.
Factor rates are typically expressed as a decimal between 1.1 and 1.5. Example: a $50,000 advance with a factor rate of 1.35 means you repay $50,000 × 1.35 = $67,500 total, regardless of how quickly you repay.
Factor rates are most commonly used in merchant cash advances, short-term revenue-based finance, and some invoice finance products.
Why does the distinction matter?
Because factor rates and interest rates are not directly comparable. A factor rate of 1.3 over 12 months sounds like 30%. But that 30% is applied to the full principal from day one, not to a reducing balance. Expressed as an equivalent APR, a 1.3 factor rate over 12 months is roughly 45–55% APR.
This doesn't mean factor rate products are bad. Short-term, fast-access capital sometimes has a higher cost. The question is whether the cost is proportionate to the value you're getting.
How to compare loan costs properly
- →Total repayment amount — the simplest comparison. What is the total you will repay?
- →Annualised Percentage Rate (APR) or Comparison Rate — includes fees and expresses total cost annually
- →Weekly or monthly repayment amount — can your cash flow actually service this?
- →Early repayment terms — with factor rates, early repayment often doesn't reduce your cost
Common fees to watch for
- →Origination or establishment fee — typically 1–3% of the loan amount
- →Monthly account fee — a flat charge regardless of balance
- →Early repayment fee — charged if you pay out before the agreed term
- →Missed payment fee — charged if a scheduled repayment fails
- →Renewal fee — charged when refinancing or extending
A worked comparison
Two lenders offer a $80,000 business loan over 18 months:
| Lender | Structure | Total cost |
|---|---|---|
| Lender A | 22% p.a. reducing balance + $1,500 fee | ~$19,700 |
| Lender B | Factor rate 1.28, no fee | $22,400 |
In this example, Lender A is cheaper despite the higher headline rate, because the reducing balance means you pay less interest as the principal decreases.
Questions to ask any business lender
- →Is this an interest rate on a reducing balance, or a factor rate on the total principal?
- →What is the total amount I will repay over the full term?
- →What fees apply — upfront, monthly, and on exit?
- →What is the comparison rate or APR?
- →Does early repayment reduce my total cost?
- →What happens if I miss a payment?
The bottom line
Understanding how your loan is priced — not just the headline number — is the difference between a well-priced funding decision and an expensive one. What matters is the total cost for your specific situation, and whether that cost is proportionate to what you're getting.
Compare offers
See indicative total costs across multiple lenders
Two-minute application. No credit check to start.
Check your eligibility →General information only. Not financial advice. Rates and figures are indicative examples only. Consult your accountant or financial adviser before entering into any credit arrangement.