Merchant Cash Advance vs. Bank Loan: 5 Key Differences

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If you need funding for your small business, there are many financing options. Depending on your situation, needs and goals, you may be considering a merchant cash advance (MCA) or a bank loan.

Before signing away for the funds, it’s important to note that the two options couldn’t be more different in many ways. Here are the five biggest differences to keep in mind as you shop around and compare options.

Merchant Cash Advance vs. Bank Loan: 5 Differences to Note

When comparing a merchant cash advance vs. a business loan, here’s what borrowers need to know about how their features break down.

1. Costs

Whether you’re looking to apply for a merchant cash advance or a traditional bank loan, there are costs associated with accessing funding for your business. But how costs for those funding options are calculated are very different.

With a bank loan, you’ll get a more traditional approach. The lender will assign you an interest rate based on business or possibly personal creditworthiness, and it’ll be represented as an annual rate. The lender uses that rate to amortize your loan, and each payment will include both principal and interest.

In some cases, lenders may also charge additional fees, such as origination fees, late fees and more.

If you pay off the loan early, you can typically save on interest because interest accrues as you pay it down.

With an MCA, the purchaser charges a fixed amount of interest using what’s called a factor rate. If you have a 1.2 factor, for instance, you’ll pay 20% of the advance amount in interest — for a $10,000 advance, you’ll ultimately pay back $12,000.

Remember, though, that the amount of interest is fixed, so if you pay back the funds ahead of schedule, you don’t benefit.

It’s also important to note that merchant cash advances are far more expensive than small business loans. With bank loans, you may be able to secure an interest annual percentage rate in the single digits, while merchant cash advance factor rates can be much higher.

2. Eligibility Criteria

Bank loans can be difficult to get as a small business owner. Banks tend to have the strictest eligibility requirements because new businesses have a high failure rate. That means you may need to have been in business for two or more years and meet annual revenue requirements.

In addition to your time in business and your revenue, banks will also consider several other factors, such as your:

  • Business credit history
  • Personal credit score and history
  • Other debts
  • Collateral
  • Cash flow
  • Business plan

With a merchant cash advance, the credit requirements are far less stringent, as are the operating requirements. As a result, newer businesses may qualify if they meet other criteria.

Instead of focusing more on credit history, your cash flow is the most important factor. Merchant cash advance providers will review your credit and debit card sales or your bank statements to determine if you have the cash flow required to make your payments.

3. Repayment Process

With a small business loan from a bank, you’ll make monthly payments, with each one paying accrued interest and some of your principal balance. The repayment schedule is similar to other installment or term loans that you might be familiar with, such as mortgage, auto and personal loans.

With MCAs, your payments couldn’t be any more different. Instead of monthly payments, you may have payments taken from your monthly or daily credit sales or bank account.

Additionally, if your merchant cash advance is based on your debit and credit card sales and receivables, you’ll typically have a percentage taken out instead of a fixed amount. This can be helpful during times when sales are down, but that also means it’ll take you longer to pay off the debt.

If you have an ACH merchant cash advance, which is based on the income and expenses in your bank account, the daily or weekly payment may be a fixed amount.

4. Speed

While bank loans are generally better than merchant cash advances, they can take several weeks or even months to close. If you don’t necessarily need the funding quickly, this may not be a big deal. You’ll generally get your loan as a lump sum once the process is complete. But if you’re in a bind financially, it may take too long.

On the flip side, merchant cash advances have a much shorter application process. MCAs can fund within a day or two after you’ve applied and been approved.

This speed can give merchant cash advances a big advantage when compared to bank loans. But remember, there are trade-offs that borrowers have to make to get that speed, and the costs may not be worth it.

5. Purpose

Like other forms of business financing, bank loans and merchant cash advances serve different purposes and business needs. It’s highly likely that if you’re considering one, you may not even be in the market for the other.

A bank loan is a better fit for small business owners who need a lot of capital for some major investments in their company and have the credit score to back up for traditional funding. That may include some working capital needs, but it may lean toward equipment, research and development and other major financing needs.

And again, because bank loans tend to take a while to fund, they’re better for long-term business planning compared to short-term financing needs.

In contrast, merchant cash advances are generally used by small business owners who have short-term cash flow issues. For example, you may consider one to help pay a vendor, to cover payroll or to buy much-needed inventory or supplies to keep your business running. Unlike bank loans, merchant cash advances are often not considered loans, and are designed mostly for working capital needs.

This is also why they tend to be more expensive because they’re short-term in nature.

Merchant Cash Advance vs. Loan: Which Is Better?

For the most part, if you’re considering financing for your business, it’s best to consider anything other than a merchant cash advance.

This form of financing — it’s technically not even a loan — is expensive. What’s more, many merchant cash advance contracts can contain predatory language that could put the business at a severe disadvantage if they can’t afford to repay the debt.

So even if you just need some money for everyday expenses, it may be better to consider a business credit card or an online business loan or line of credit. While online loans and lines of credit are more expensive than bank loans, they’re generally much cheaper than merchant cash advances, and they also have more favorable repayment terms and safety nets if you can’t make your payments.

That said, if you’re looking for long-term financing, merchant cash advances shouldn’t be on your radar at all because they’re geared more toward short-term needs. If your business has been operating for several years and you have solid revenues and an established business credit history, you may qualify for a bank loan or government loan through the SBA.

However, in the event that you need long-term financing but don’t meet those criteria, consider an online loan or line of credit, or even a micro loan if your business is just getting started.

The Bottom Line

If you’re comparing a merchant cash advance vs. bank loan, it’s crucial that you take the time to understand the differences and how each can help you. Additionally, if you need capital for your company, consider other forms of business financing and do your due diligence to determine which is the best option for you.

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