The True Cost of Financing: Interest Rates, Factor Rates, and APR

One offer says 10% interest. Another says a factor rate of 1.25. A third quotes "just $300 a day." They are all describing the price of money, but in three different languages, which makes it easy to pick the one that sounds cheapest instead of the one that is.

This lesson gives you a simple translation kit: how each pricing method works, how to turn any offer into total dollars and an annual rate, and what fine print to check.

Interest rates: simple vs amortizing

Simple interest is charged on the full amount for the full term. Borrow $10,000 at 10% simple interest for one year and you owe $1,000 in interest no matter how you repay.

An amortizing loan charges interest only on the balance you still owe. Each payment covers that period's interest and chips away at principal, so interest shrinks over time. The same $10,000 at 10% repaid monthly over a year costs about $550 in interest, because you are not borrowing the full $10,000 all year.

Factor rates: total payback in one number

Many short-term products, including revenue-based financing, use a factor rate. Multiply the amount you receive by the factor to get what you repay. The cost is fixed up front and does not shrink as you pay.

Why short terms make APR look high

APR (annual percentage rate) expresses cost as a yearly rate, including most fees. Because it annualizes, a fixed dollar cost paid over a short time produces a large APR. The same $15,000 cost on $50,000, paid back in daily installments, works out to an APR of roughly 109% over six months and roughly 55% over twelve months.

Notice what each column tells you. Cost per dollar borrowed (total cost divided by amount received) shows how many cents each dollar costs. APR shows how expensive that money is per unit of time. You need both: a cheap-looking total can hide a fast, demanding payment schedule, and a high APR on a short need may still be a small dollar cost.

Fees and prepayment terms

• Origination or underwriting fees are often taken out of the amount you receive. A 3% fee on $50,000 means $48,500 lands in your account, but you repay as if you received $50,000, which raises the true cost.
• Other fees can include closing, draw, maintenance, late, and returned-payment (NSF) fees. Ask for a full list in writing.
• Prepayment terms matter. With amortizing loans, paying early usually saves interest (check for prepayment penalties). With factor-rate products, the full payback is often owed even if you pay early, unless the contract offers an early payoff discount.