If you’re unfamiliar with the term credit card processing loans, more familiar terms might be business cash advance or merchant cash advance (MCA). Although many people refer to them as loans, they aren’t really a loan but rather an advance on credit card sales deposited into a small business’ merchant account.
Many small business owners that accept credit and debit cards, instead of using short-term loans, leverage their regular credit card transactions to access borrowed capital via a cash advance based upon their future credit card sales. This type of financing is easy to access if you have good credit card volume, but is expensive, so it’s important that you understand the costs as well as what makes a merchant cash advance (or business cash advance) different from a typical small business loan.
How Does a Credit Card Processing Loan, or Rather, a Business Cash Advance Work?
An MCA is typically a direct debit from your merchant account based upon a percentage of the value of credit card transactions in that account. Typically these direct debits are daily, but there are some MCA providers who debit on a weekly basis. Unlike a typical business loan with fixed payments (which can also be daily or weekly), repayment can fluctuate based upon the amount of credit card receipts in your merchant account.
MCA costs are not expressed in APR, but providers use what’s called a Factor Rate. Think of the Factor Rate as a calculation rather than an interest rate percentage. For example, if you are quoted a factor rate of 1.5, that means for every dollar you borrow you will pay back $1.50—or repay an additional $.50 for every dollar borrowed.
If you were to borrow $10,000 at a factor rate of 1.5, you would pay $15,000 back to the MCA provider. $10,000 x 1.5 = $15,000 (the cost of your MCA would be $5,000).
I mentioned earlier that your periodic payments (whether daily or weekly) can fluctuate based upon the credit card receipts in your merchant account. This is due to what’s called the holdback. This is a term that applies to an MCA, but does not apply to a short-term business loan.
Borrowers often confuse the holdback with the rate they will pay for the advance, but the holdback and the factor rate are not the same thing.
The holdback refers to the percentage of your daily credit card sales that will be debited from your account with every periodic payment. The holdback is typically 10% to 20% of your credit card receipts and the percentage will remain fixed through the term of the advance until the entire amount is paid in full.
Using the above example of a $10,000 MCA, and a holdback of 15%, if $5,000 was deposited into your account today, the holdback would be $750. 15% of $5,000 is $750. If you received $2,000 in credit card sales tomorrow, the holdback would be $300. 15% of $2,000 is $300.
The holdback amount will vary depending on the amount of daily credit card sales your business does each day. In other words, on those days when you take in a lot of credit card sales, the debit will be greater than on those days when you do less. In some cases, this type of financing can benefit businesses that don’t have a steady volume of credit card sales each day.
Advantages of a Merchant Cash Advance
Although a Merchant Cash Advance can be an expensive way to fill a short-term capital need, it is a relatively easy way for restaurants, small retailers, and other businesses that accept credit cards, to access capital quickly—even if they wouldn’t qualify for a traditional small business loan at the bank. That doesn’t mean the only people that use MCAs have less-than-perfect credit, but it is one of the business financing options available to a merchant that doesn’t have a 650 or better personal credit score.
I think the single biggest advantage of a business cash advance like this is how accessible it is. If your business does $3,000 to $5,000 in monthly credit card volume and you can demonstrate a consistent cash flow throughout the month, you may likely qualify for an MCA. MCA providers weight your personal credit profile (as part of the creditworthiness conversation) differently than a loan officer at a bank. They are more interested in the volume of credit card transactions you process through your business and whether or not you have the resulting cash flow to make each and every periodic payment. Yet, don’t interpret that to mean that an MCA is available to any borrower regardless of how low their credit score may be, but the qualifying criteria is much less stringent than many other lenders or financial products.
Speed to funding is another advantage that can’t be ignored. Most MCA providers can make a decision very quickly—even the same day—and can have funds deposited in your checking account the next day. If you need additional capital to take advantage of an opportunity to capture additional ROI by purchasing inventory, for example, you might not have a few weeks to wait for an answer at the bank. In some cases, the opportunity cost of missing such an opportunity is far greater than the costs associated with a business cash advance.
How to Apply
Applying for a merchant cash advance can be fast and easy. Most providers are online with an online application. You may (depending on the provider) speak with a representative that will walk you through the process and make sure you understand the terms and conditions associated with the MCA. And, as mentioned earlier, can usually give you an answer on your application the same day—sometimes within a few minutes.
As mentioned above, qualifying for a business cash advance is fairly straightforward and providers evaluating your application focus less on your credit profile and more on the number of your credit card transactions. If you can demonstrate, with 3-4 months of bank statements, that you have the cash flow to service the advance, and have the number and amount of credit card transactions (this will vary depending on the provider), you are more likely to be approved.
If you can demonstrate the ability to make each and every periodic payment, you don’t need to have a perfect credit profile to qualify for financing based on your credit card processing.
Alternatives to Credit Card Processing Financing
There are a number of other small business financing options available in addition to a merchant cash advance depending on your personal credit score and business credit profile. They include:
- Business Credit Cards: Like an MCA, a business credit card is relatively easy to qualify for when compared to a traditional loan or line of credit and is a good way to access borrowed capital. A business credit card is also a good way to build or establish a strong business credit score.
- Invoice Financing (Factoring): This financing option is also not a loan. A third party, know as a factor, purchases your account receivables at a discount so you can have access to capital now, rather than waiting for the 30- to 60-day terms you offer your customers. The factor may purchase all, or part, of your invoices. The factor will normally pay you a percentage of the agreed upon amount now and pay the balance once he or she is able to collect from your customer.
- Traditional Bank Loans: Qualifying for a traditional term loan from financial institutions like banks and credit unions usually require a personal credit score above 680 and a monthly repayment frequency (although many traditional lenders are going to a weekly periodic payment frequency for some small business loans). These loans aren’t typically available to business owners with bad credit.
- Cash Flow Loans: These loans are often offered by online lenders and will be more familiar to the borrower used to working with a traditional bank or credit union. Repayment period, or term of the loan, can be anywhere from three months to four or five years depending on the lender. And, like the other lenders mentioned, any origination fees, repayment terms, and available loan amounts will vary from lender to lender. An easy online-application and a quick answer on loan applications make an online loan or line of credit a popular option for many small business owners.
There are a number of ways for a small business owner to borrow for fueling growth or funding other working capital needs in addition to credit card processing loans or a merchant cash advance.
Some of these options will require a stronger credit profile than others. If you’re interested in seeing your free business credit scores, Nav can help.
Nav’s Final Word: Credit Card Processing Financing
Although it would be incorrect to refer to a merchant cash advance as a credit card processing loan because it’s not really a loan, but rather a cash advance based upon a business’ daily credit card receipts, it is a financing option available for a business looking for quick access to capital. It does, however, come at a premium cost.
It’s important to make sure you understand that there are distinct differences between a merchant cash advance and a business loan and that costs are expressed differently and repayment is also handled differently.
Not all MCAs or MCA providers are created equally either. Costs, fees, repayment terms, and even customer service can vary widely. One of the lending and credit experts at Nav can help you determine if this type of financing is right for you and your business—or if something else would be a better fit.