Understanding the Pros and Cons of Invoice Financing and Factoring

If you’re a business owner who collects payments from customers through invoicing and is looking to free up a significant amount of cash without having to take out a loan, both invoice financing and invoice factoring can be great options for you. However, it’s important to first understand the differences between the two, as well as the pros and cons of each, and additional financing choices to consider before you decide to go with one or the other.

What Is Invoice Factoring?

Invoice factoring is an alternative to a loan that allows you to sell your invoices at a discounted price to a designated factoring company and receive a lump sum of cash in return (typically 80–90% of the invoice totals) minus a fee set by the company. Once your customers pay the invoice factoring company — which usually takes anywhere from 30 to 90 days — you’ll receive the rest of the invoice amount from the company, most commonly as a direct deposit into your bank account. The seamless process makes it fairly quick and simple to begin using the money for working capital in a relatively short period of time.

What Is Invoice Financing?

Invoice financing differs quite drastically from invoice factoring in that you’re not selling the invoices like you are with invoice factoring, and you’ll still be dealing directly with your customers. You’re receiving what is essentially a short-term loan from a lender and pay a percentage of the invoice amount as a fee for borrowing the money.

This option, also known as accounts receivable financing, can be a better choice for your business if you’re concerned about the potential ramifications of shifting the responsibility of invoice collection to an outside company and/or don’t want your customers to have to deal with an outside vendor, especially if your business relies on building and maintaining a relationship with clients.

Pros and Cons of Invoice Financing and Factoring

The primary advantage of both invoice factoring and financing is that they allow business owners to maintain cash flow, handle the payment of bills, and pay out their employees quickly, without the need to wait for outstanding client invoices to be dealt with first. This is often a step that can cause frustration and delay for many companies that frequently find themselves waiting for clients to settle their balances. The application and approval processes are often quicker and easier than that of a loan as well, typically just requiring a credit check to verify that your business is financially stable. Along with an application-to-funding timeline of around one to three months, they can be fairly quick ways to access cash compared to other financing methods that have lots of red tape and stringent qualification criteria.

In addition, factoring and financing are considered “unsecured,” so it doesn’t require any collateral to guarantee the funding beyond the invoices.

The biggest con of using either of these funding sources is the cost, as they can be quite expensive compared to other financing choices. Since you’re paying a premium to have the money given to you, and the financer is taking on risk by attempting to collect from your customers or provide you with the cash up front, you won’t receive the full sum of the invoices and they’ll receive a cut of the total. In addition, you may need to end up buying back the invoices that aren’t collected or agree to a recourse situation. Depending on the company you go through, extra fees usually range from 1-5%, but for financing providers who bill per total invoice value per week, this can balloon into massive APRs of nearly 80%, so it pays to do your homework on the specific lender.

With invoice factoring specifically, you’ll also need to be comfortable relinquishing control over your invoices and involving a third party — once you sell your invoices to them, your customer will need to work directly with that company to handle the payment of their invoice. Depending on your industry and the nature of your relationship with your customers, this can potentially have a negative effect on your future interactions.

Of course, your business also needs to collect invoices from vendors or clients for factoring to be a viable choice; if you rely on a different method for payment, you won’t be able to consider this option.

Who Offers Invoice Financing and Factoring?

For invoice factoring, you’ll need to work with a specialty factoring company, as this service isn’t offered by traditional finance providers. Similarly, invoice financing is typically not available through banks and credit unions — but some online lenders and fintech companies provide it.

Alternatives to Invoice Financing and Factoring

If you’re a homeowner who doesn’t feel like invoice factoring or financing is right for you or you’re having a hard time finding a company that’s a fit, there are more than a few other ways to access cash for your business, specifically through your home equity.

Home equity loan alternative

With a home equity loan, you borrow against the equity you’ve built in your home with the house serving as a guarantee on the loan. Unlike a business line of credit, you aren’t required to pay the balance down to zero every year. There are several other advantages to this option, including a fixed interest rate, consistent monthly payment, and flexible repayment period that typically ranges from 5 to 15 years. There are downsides to be aware of, however. Since a home equity loan is another mortgage on your home, it means another payment you’ll need to make each month on top of your first mortgage. And depending on the specific requirements of your lender, the application and approval process can be quite lengthy and challenging.

Home equity line of credit (HELOC) alternative

A HELOC lets you access funds whenever you’d like, and you can take out as much as you want — up to the maximum amount you qualify for — without any penalties. Compared to a loan, application and approval might be a bit easier, and repayment timelines are usually between 15 and 20 years. On the other hand, HELOCs have variable (read: unpredictable) interest rates, so your monthly payment can fluctuate significantly. You also run the risk of having your line of credit frozen by the lender if your credit score or home value drops below a certain threshold.

Cash-out refinance alternative

A cash-out refinance essentially replaces your current mortgage with one that has a larger balance than what you owed and provides you with the difference. While you have the opportunity to lock in a lower interest rate with a refinance, you are paying off a new mortgage, so this option lengthens your timeline and you’ll run into the same fees you dealt with the first time around.

Home equity investment vs. invoice financing

A home equity investment lets you access the equity you’ve built in your home and gives you cash in exchange for a share of the home’s future value in as little as three weeks.¹ You can use the money toward whatever your business needs, without the hassle of monthly payments.

Tap into your equity with no monthly payments. See if you prequalify for a Hometap investment in less than 30 seconds.