As a small-business owner or independent operater, you’re used to taking risks – risks that don’t always work out. Maybe you took some chances with your business that didn’t go as planned. That could leave you unable to pay the bills for a few months. In turn, that could damage you or your business’ credit score.
Small-business owners who suffer from low or bad credit have fewer options for financing. Luckily, there are still ways to access capital. One strategy is to take out a merchant cash advance. Before you start the process, understand the risks.
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What is a merchant cash advance?
A merchant cash advance is not a loan – it is a commercial transaction. Lenders buy a percentage of your future credit or debit card sales, minus fees.
Because of this, lenders are primarily concerned with the consistency and volume of your business sales. This is useful for business owners or business’ that suffer from a low credit score and and need capital.
It is relatively easy for a business with poor credit to qualify for a merchant cash advance rather than a personal loan. Many lenders offer financing for business owners with credit scores as low as 400. Other lenders don’t run a credit check at all.
Because of this, lenders may require a minimum time in business. Other eligibility factors are likely to apply as well, but the criteria is typically quite lenient.
This may sound ideal on the surface, but lender offset their risks. The lower your credit score, the more expensive the cost of the advance. A no-credit-check advance will carry the highest rates.
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Merchant cash advance rates
The cost of a merchant cash advance is not illustrated using an annual percentage rate (APR). Annual percentage interest rates are reserved for conventional loans that rely on your credit score. Cash advance lenders instead use what is called a factor rate to price the business cash advance.
Factor rates charge interest on the entire principal over the entire life of the loan. These factor rate are typically between 1 and 1.5. Factor ratesare multiplied by the total advance (principal) amount to determine the total repayment.
This is very different than APR, which calculates interest based on the outstanding loan balance. This means that the amount of interest decreases over the loan term.
The cost difference is substantial. For example, a $10,000 cash advance with a factor rate of 1.3 will cost you $3,000 ($10,000 x 1.3 – $10,000). If you agree to repay the cash advance lender 15 percent of your estimated monthly sales of $6,000, the equivalent APR would be 46.24 percent. In comparison, loans backed by the U.S. Small Business Administration (SBA) carry rates that top out at about 9 percent. Even high-interest credit cards have APRs of less than 25 percent on average.
For business owners who have low credit, or require a no credit check application, expect high factor rates. These rates will sometimes equate to an annual percentage rate in the triple digits.
Although the costs can be higher than conventional business loans, there are times when a cash advance is your only option.
Merchant cash advances are among the most expensive forms of business financing. Lenders charge for ease and speed. These loans are typically for businesses that can’t access conventional financing. Before opting for a business cash advance, consider researching other options.
Some conventional lenders work with businesses that have bad credit, a past bankruptcy, or other issues with their credit. It might pay to check with conventional or SBA-backed loans to see if you’re eligible. A difference of just a few percentage points could mean the difference between profit and loss.
Another no-credit-check business financing option is a hard money business loan. Hard money loans are issued by private lenders and secured by an asset, typically real estate.
Hard money lenders care more about the value of the property securing the loan. Because of this, hard money lenders often accept low credit scores or are uninterested in credit scores altogether. While hard money business loans can carry high interest rates than conventional loans, their rates are still considerably lower than a cash advance. Just note that your property is at risk should you default.
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