Consider the Cost: Traditional Loans vs. Merchant Cash Advances
The amount that you pay for funding when using a Merchant Cash Advance is typically looked at as a factor rate. The factor rate is derived by looking at the relationship between the amount of money advanced and the amount of money “paid back.” If an advance of $10,000 is given and an amount of $12,800 is repaid, this would be described as a 1.28 factor rate. While a Merchant Cash Advance is not technically what would be considered “factoring” in the financial world, factor rates have traditionally been used to objectify payback when an interest rate does not apply.I’ve heard many people refer to Merchant Cash Advances as “expensive money.” Every time I do, I cringe a little. Not because I agree, but because people often do not understand what how “expensive” traditional loans truly are.
Let’s look at a home loan, for example. An interest rate of 6% is “cheap money,” right? It certainly seems like it. But when you look at the terms of that loan, amortized over 30 years, you see just how expensive that money can be. Take a typical $250,000 home, for example. When all is said and done, that tiny 6% interest rate will result in you paying $539,596. That’s a factor rate of 2.16! What’s worse: that 6% interest rate is fully guaranteed by the value of your home (which the bank owns.) If anything goes wrong, the bank can just take the house. If the house isn’t worth quite what they paid for it, they’ll come after you for whatever else you have of value. Talk about expensive money.
