Merchant cash advances can be very tempting when you’re a business owner in need of quick cash. Whether you need the cash to pay bills, pay salaries, or even to pay off a previous cash advance, they can cover you in an emergency. The upfront sum is expected to be paid back via credit or debit card sales. Increasingly, some cash advances have been arranged to be paid off via ACH transactions. This article will cover important information about merchant cash advances, including rates and how they are determined.
What is a Merchant Cash Advance?
A merchant cash advance is a lump sum of money provided to a business in need of cash. The business is then expected to pay the money back by automatic withdrawals from your bank account. Another option is to pay the money back with future credit or debit card sales. These cash advances have typically been used by retail stores and restaurants. When the business pays back by using future credit or debit card sales, the amount paid back is based on sales. The higher your sales, the faster the cash advance will be paid off.
How Are Merchant Cash Advances Regulated?
Typical business loans are regulated by laws such as the Truth in Lending Act, which requires lenders to disclose information such as annual APR, total amount paid if only minimum payments are made, and any fees. Merchant Cash Advances fall under commercial transactions. As a result, there is no oversight or regulations of these cash advances. They are instead regulated by each state’s Universal Commercial Code. Some states will make this a better deal for borrowers, while other states make this transaction a better deal for the lenders.
How Are Rates Determined?
The lenders of the cash advances determine the factor rate, which is then multiplied by the amount of the advance. The final number is what determines the total payoff amount. Rates are determined by looking at the business’s tax returns, bank statements, and number of years in business. The most important documents they will want are your credit card statements. For businesses repaying the advance via future credit card sales, the sales from credit and debit cards determine your monthly payment. The lenders will want to see higher sales in order to receive higher payments.
What Are Typical Factor Rates?
Factor rates for merchant cash advances will generally range from 1.1 to 1.5. This rate is then multiplied by the amount loaned to determine the repayment amount. If a business is provided with a cash advance of $20,000 at a factor rate of 1.5, their total repayment amount will be $30,000.
Important Things to Consider With Factor Rates
It is important to note that factor rates are not the same thing as interest rates. In the example given above, it might be easy to assume that the interest rate is only 50%. However, the interest is charged the day the loan is created. The amount to pay off will not change regardless of early payments. As a result, there is no benefit to paying off the loan early.
Merchant cash advances can come at a high cost to businesses. The payments are determined by credit card sales. This can lead to cash flow problems if your sales slow down or a client does not pay you on time.
Finally, effective interest rates on these loans are often well over 100%. The loans are short term and are generally paid off within 6 months. In the example above, the extra $10,000 will be paid off over six months. If the daily payment is around $166, the effective APR is 174%. If for any reason you are not able to make that payment, you can find yourself in a cycle of debt as you take out more cash advances to pay off previous ones.
For some businesses, merchant cash advances are an easy and quick method of obtaining much-needed cash. It is recommended that you do your research and aim for the lowest factor rate possible in order to keep the effective interest rate as low and manageable as possible.