The True Cost of Short-Term Business Loans: Factor Rates, Fees and What You Really Pay

"Borrow $100,000, repay $120,000." It sounds like 20% interest. For a six-month loan repaid daily, the real annual cost is closer to 75%, and higher again once fees are included.

Short-term business lending is often quoted in ways that make it hard to compare with a bank loan or with other offers. That doesn't make it a bad product. Fast, unsecured funding has a real cost, and sometimes it's worth paying. But you should know what that cost is before you sign. This article shows you how to work it out.

How Short-Term Loans Are Priced

• Factor rate. A multiplier applied to the amount borrowed. A factor rate of 1.20 on $100,000 means you repay $120,000 in total, regardless of how long it takes. It's a fixed cost, not an annual rate.
• Simple or flat interest. Interest calculated on the original amount for the whole term, even though you're paying it down. Similar effect to a factor rate.
• Annual interest rate. Interest on the outstanding balance, as on a bank loan. This is the only format you can compare directly with bank pricing.
• Fees. Establishment, origination, broker, account-keeping and drawdown fees. An establishment fee is often deducted from the amount you receive, so you pay interest on money you never get.

Why a Factor Rate Costs More Than It Looks

With a factor rate, you pay the full cost on the original amount. But with daily or weekly repayments, you start paying the loan back almost immediately. On average, you only have about half the money for the full term. The cost is the same, but you've had the use of far less money, so the effective annual rate is much higher.

A rough rule: for a loan repaid evenly over its term, the effective annual rate is a little under double the "headline" rate, then scaled up to a full year. A 20% factor cost over six months works out at roughly 75% a year.

Worked Examples

All examples are for $100,000. The annual rate shown is the nominal annual interest rate the repayments represent, the figure you'd compare with a bank's quoted rate. Figures are illustrative, not quotes from any particular lender.

For comparison, a $100,000 bank overdraft at 9.5% a year, fully drawn for six months, would cost about $4,750 in interest, plus fees. The short-term loan in the first row costs $20,000 over the same period.

That gap is the price of speed, of no property security, and of a lender taking a risk a bank wouldn't. Sometimes it's worth it. A $20,000 cost to secure a $150,000 profit on a stock purchase is a good trade. A $20,000 cost to cover a shortfall that will happen again next quarter is not.

The Hidden Cost: Early Repayment

On a normal loan, repaying early saves you interest. On many factor-rate loans, it doesn't. You owe the full $120,000 whether you repay in six months or three.

If you repay the first loan above in full after three months with no discount, the effective annual rate rises from about 75% to about 99%, because you've paid the full cost for half the time. Some lenders offer an early payout discount, often a reduction in the remaining cost. Ask exactly how it's calculated, in writing, before you sign.

Daily Repayments and Your Cash Flow

Daily or weekly repayments affect more than the rate. A daily debit of $952 takes about $4,760 out of your account every week, from the first week. Before signing, check that your weekly cash inflows can cover that comfortably in your slowest weeks, not just your average ones. If you're not sure, choose weekly or monthly repayments, even at a slightly higher price.

How to Compare Offers

Ask every lender for the same four numbers:

• Amount received. What lands in your account after fees are deducted.
• Total repayable. Every dollar you'll pay, including all fees.
• Repayment schedule. The amount and frequency of each repayment.
• Early payout terms. What you'd owe if you repaid in full after one, three and six months.

With those four numbers you can compare any two offers, whatever format they're quoted in. Your broker or accountant can turn them into an effective annual rate in a few minutes.

Questions to Ask Before You Sign

• Is this an annual rate on the reducing balance, or a factor or flat rate?
• Which fees are deducted from the amount I receive?
• What does the loan cost if I repay it early?
• Are there default fees or penalty rates if a repayment is dishonoured?
• Is a personal guarantee required, and what security is being registered?
• Is the lender a member of AFCA?

Can You Get Something Cheaper?

Often, yes. Before taking a short-term unsecured loan, check whether one of these fits:

• Invoice finance, if the shortfall is caused by customers paying slowly. See invoice finance.
• A business overdraft or line of credit, if the need is recurring. See business overdrafts.
• Trade finance, if you're paying suppliers for stock. See trade and import finance.
• Asset finance or equity release, if you own equipment outright. See releasing cash from equipment.
• An ATO payment plan, if the shortfall is a tax bill. See financing ATO debt.

How We Help

We compare short-term and cash flow offers from across our panel on a like-for-like basis, so you can see the real cost of each. Where a cheaper product fits your situation, we'll tell you. Where a short-term loan is the right answer, we'll help you pick one with fair early payout terms and a repayment schedule your cash flow can carry, and plan the move to cheaper finance. See bank vs non-bank lenders.

Book a free, no-obligation consultation and we'll show you what your current offers really cost.