What is a Merchant Cash Advance?
When your business is strapped for cash, you may be looking for quick ways to dig yourself out of a hole. In these situations, many businesses may turn to merchant cash advance to get cash fast.
However, merchant cash advances (or “MCA”) are often too good to be true. As a result, they may not be the best decision for your business. By understanding more about merchant cash advances, you can make an informed decision about how to handle your business debt.
How do merchant cash advances work?
Merchant cash advances have traditionally been most common with businesses that do most of their sales via credit or debit card, such as retailers. Businesses get cash upfront in exchange for a portion of their future credit and debit sales or by remitting debits from your bank account on a monthly or weekly basis. The latter has become popular recently. It allows lenders to approach businesses that don’t primarily work in credit or debit sales. Either way, the agreement includes a set percentage of your sales that will go to the lender as repayment. The most important thing to note is that these repayments are not made on a monthly basis like a traditional loan. Instead, they’re made weekly, and a fee is charged to the business each time a payment is made.
How much do merchant cash advances truly cost?
The fee charged on the merchant cash advance is determined by the business’s ability to repay the loan based on a risk assessment. The fee charged is a factor of the amount you borrowed from the lender. These fees generally range from 1.1 to 1.6 based on your perceived risk in the eyes of the lender. However, that means your business is paying 10 to 60 percent of the original loan amount in fees. While a 1.1 rate doesn’t seem so bad, a rate of 60 percent is a high price to pay. For example, if you borrow $50,000 and have a factor rate of 1.4, you will end up repaying a total of $70,000, which represents $20,000 in fees. Origination or closing fees may also be charged on top of the factoring fee.
How long do you have to repay?
The repayment period on a merchant cash advance typically ranges from three to 12 months. The repayment term is based on the percentage of sales that the lender is taking. Payments – the portion of your sales or debits – must continue until you’ve paid off the entire balance including fees. However, the more sales your business makes, the more quickly you’ll be able to pay off the loan. While this gets you out of debt sooner, it will drive your effective APR up. Because the lender is taking a set percentage, when your business is making more money, the amount that the lender can take from your sales also grows. As a result, your daily or weekly payment will be greater, and the shortened timeline will increase the effective APR. Because of this, merchant cash advances can become sky high and can even soar into the triple digits.
When your business is in dire straits or short on cash, making decisions about how to get out of it can be difficult. Merchant advances can be an extremely tempting option. They allow you access to cash quickly without going through the lengthy, tedious process of applying for a business loan. However, before taking out a merchant cash advance, you should understand what it truly means for your business. The reality is that very few businesses can use merchant cash advances effectively.
If your business is struggling to make the daily or weekly payments from a merchant cash advance loan, contact the business debt team at Tayne Law Group today to help relieve the pressure.