How Interest Rates Affect Merchant Cash Advances
As discussed in Episode 25 of my podcast, “Traditional Investing Is Dead,” mortgage and credit card rates are directly tied to Federal Reserve interest rate hikes. My investors have asked me many questions about how merchant cash advances are affected by rising interest rates.
The Federal Reserve Bank of the United States has raised rates by 0.75 basis points in the last three consecutive meetings, indicating that it will continue to raise interest rates for the foreseeable future. The Federal Reserve Bank, while a private institution operating under charter with the United States government, sets monetary and interest rate policies for financial institutions. This happens through several tools such as the overnight lending rate.
Many borrowers, consumers and businesses are affected by the interest rates they pay on new and existing debt. however, the speed of impact depends on the type of financing they have agreed with the lender.
Several types of interest rates:
Two of the most common forms of credit are mortgages and credit cards. Both are available with fixed or variable interest rates. Fixed interest rates are exactly what their name suggests: fixed. While variable interest rates are linked to other types of interest rates such as prime rate (America) or SOFR (better known as LIBOR-England). The interest rate paid by the borrower may change when the interest rate or the underlying index changes.
Popularity of merchant cash advances:
Alternatives to traditional bank financing have emerged for small and medium enterprises in the form of merchant cash advances (MCAs). MCAs have grown dramatically since their inception in 2008.
Historically, MCAs were structured as a lump sum payment to a business in exchange for an agreed percentage of future credit card and/or debit card sales.
While a traditional bank will look at the borrower’s creditworthiness and other factors such as assets available as collateral, a merchant cash advance lender will look at the underlying cash flow and other factors to make a funding decision.
The speed, ease and rates at which a borrower can obtain financing with a merchant cash advance have partly fueled its growing popularity.
How Interest Rates Affect Merchant Cash Advances:
Interest rate policies set by the Federal Reserve Bank have no effect on the rates charged by merchant cash advance lenders. MCAs are not a loan, but a purchase of future receivables. Therefore, interest rates are not used by the MCA lender to determine the purchase price of such receivables. In other words, a borrower will pay a percentage of short-term accounts receivable based on its underlying risk profile. As a result, the rate paid on a merchant cash advance will not change based on a change in the interest rate set by the Federal Reserve. Moreover, it is likely that the more the cost of capital via traditional funding sources increases due to rising interest rates, the more attractive alternative forms of funding, such as MCAs, will become.
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