Many mortgages and credit card rates change as interest rates increase, how do interest rates affect merchant cash advances?
The United States Federal Reserve Bank has been indicating for some time that it was going to be increasing interest rates in the near future. The Federal Reserve Bank, while a private institution operating under charter with the United States Government sets monetary and interest rate policy for financial institutions. This is done through the use of several tools such as the overnight lending rate that they have at their disposal.
Many borrowers, consumers and businesses alike are affected by the interest rates that they pay for both new and existing debt. Whether or not they are impacted on existing debts depends upon the type of financing they have to what has been agreed upon between the borrower and lender.
Types of Interest rates
Two of the most common form of consumer debt instruments are mortgages and credit cards. Both are available with fixed or variable interest rates. Fixed interest rates can only change under certain circumstances and when they do, the lender must send advance notice before the rate is changed.
In contrast, variable interest rates are tied to other interest rates such as the Prime rate or LIBOR. The interest rate that the underlying borrower pays may change when the underlying interest rate or index changes.
The increasing popularity of merchant cash advances
Largely, as a result of new technology, alternatives to bank financing have emerged for small to medium sized businesses. Merchant cash advances are one such alternative that has been growing dramatically in recent years.
Merchant cash advances leverage technology to improve upon the underwriting process. Leveraging the Internet and complex software, a lender can partly automate the financing application review process and render a decision much quicker and at a much lower cost than a traditional bank.
While a traditional bank will look at the creditworthiness of the borrower and other factors such as the assets available as collateral, a merchant cash advance lender will look at the underlying cash flow and other factors to render a funding decision and amount.
The speed, ease, and rates that a borrower can secure funding with a merchant cash advance has in part fueled its increased popularity.
These developments beg the question, how does current interest rate policy affect the rates charged on merchant cash advances?
How do interest rates affect merchant cash advance rates?
Interest rate policy set by the Federal Reserve Bank don’t have any effect on the rates charged by merchant cash advances. Merchant cash advances can be viewed as not charging an interest rate to borrow money but rather as a percentage of collectables based upon future receivables.
Stated another way, a borrower will pay a percentage of short-term accounts receivable based upon their underlying risk profile. As a result, the rate paid on a merchant cash advance will not change based upon a change in monetary or interest rate policy set by the Federal Reserve.