Compared to traditional bank loans and credit cards, merchant cash advances are a relatively new type of business funding. However, in the short time they have been around, many myths and misconceptions have sprung up about them. If you are a business owner, it’s important to understand the truth behind both the positive and the negative myths so you can clearly see whether or not a merchant cash advance is right for your situation.
Things to Know About a Merchant Cash Advance
Myth: Merchant cash advances are loans.
Truth: In many ways, merchant cash advances function just like loans. The lender gives the borrower money which the borrower then repays. However, there is a big difference between the repayment of merchant cash advances and loans. Loans typically require a set repayment schedule for the life of the loan, and traditionally, with installment loans including signature loans, mortgage car loans and business loans, the borrower pays the same payment every month for the life of the loan.
With a merchant cash advances, however, borrowers pay a set percentage of their credit card sales. Rather than paying only once a month, borrowers make payments every time they receive credit card payments from their clients. Essentially, a merchant cash advance is an advance on future credit card payments, rather than a loan. For some merchants, this is exactly the set up they need, as their payments are gauged perfectly to their revenues. For others, the almost constant payments are hard to maintain compared to the monthly payments of a traditional loan.
Myth: Merchant cash advances are better than credit cards.
Truth: This myth is partly true, but the veracity of the claim varies widely depending on the interest rate of the credit card versus the interest rate on the merchant cash advance and how you use the credit card.
Research indicates that people, whether they are business owners or private consumers, spend more and are willing to pay higher prices when they are using credit cards. As a result, a credit card statistically is more likely to tempt you into deeper debt than a merchant cash advance. However, if you take out the cash advance before deciding how you are going to spend it, there is still the risk of overspending.
In terms of interest rates, merchant advances don’t charge a set rate. Rather, they charge a nominal fee that can be translated into an interest rate as high as 38 percent. In contrast, credit cards may offer low introductory rates, but their penalty rates along with fees come very close to the rates associated with merchant cash advances.
Finally, consider the issue of repayment. As long as you have credit card revenue rolling in, your merchant cash advance will essentially repay itself. In contrast, with credit cards, you have the option to pay only the minimum each month. That can safeguard your working capital more effectively than large payments to a cash advance, but it can also lock you into debt for decades. Ultimately, you have to weigh the pros and cons to determine whether merchant cash advances or credit cards are better for your situation.
Myth: Merchant cash advances are the only option for business owners with less than perfect credit.
Truth: Merchant cash advances are designed for business owners with less than perfect credit. Rather than acceptance based on your credit score, advances take into account your business’ credit card receipts over the last year. Generally, however, if you have a bankruptcy on your credit report, you cannot access this type of funding.
However, merchant cash advances are not the only type of loan for people with less than perfect credit. Alternative lenders have also started offering lines of credit and business loans to this demographic as well. So that these lenders can create a picture of your creditworthiness that goes far past your credit scores, they leverage the power of data.
When you apply for a loan with an alternative lender or fintech company, the lender looks at a huge, diverse collection of data ranging from your seller rating on eBay, to your college grades, to your credit card receipts, to your social media profiles, and they deny or accept your application based on that and similar information. Additionally, programs like the Small Business Administration’s microloan program also exist to help get funding into the hands of fledgling entrepreneurs and small business owners who lack stellar credit.
Myth: Bank loans are better than merchant cash advances.
Truth: The truth is that “better” is a subjective concept. If you have a solid business plan and great credit, a traditional business loan typically has lower effective interest rates than a merchant cash advance, offering savings to your business. However, with rejection rates between 63 and 80 percent, traditional bank loans are simply harder to access for many people. In addition, while some borrowers prefer the predictability of an installment repayment plan, others need the flexibility of payments gauged to revenues.
When accessing funding for your business, keep in mind that the landscape of business lending has changed for both borrowers and lenders. What may have seemed like a smart funding source a generation ago may not be the best option for you now. However, in other cases, you may want to forgo new financial products and opt for a tried-and-true bank loan. Ultimately, it’s critical to dispel myths and investigate as many options as possible before diving in.