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Factoring Terminology

[EDIT]BEST INTEREST STANDARD

Internal Revenue Code Sec. 5891 and most state laws require that a court find that a proposed settlement factoring transaction be in the best interest of the seller, taking into account the welfare and support of any dependents. [11] “Best interest” is generally not defined, which gives judges flexibility to make a subjective determination on a case-by-case basis. Some state laws may require that the judge look at factors such as the “purpose of the intended use of the funds,” the payee’s mental and physical capacity, and the seller’s potential need for future medical treatment. [12] [13]. One Minnesota court described the “best interest standard” as a determination involving “a global consideration of the facts, circumstances, and means of support available to the payee and his or her dependents.” [14]

Although sometimes criticized for being vague, the best interest standard’s lack of precise definition allows considerable latitude in judicial review. Courts can consider on a case-by-case basis the totality of the circumstances surrounding the transfer to determine whether it should be approved.

[EDIT]DISCOUNT RATE

In the beginning, the factoring industry had some relatively high discount rates due to heavy expenses caused by costly litigation battles and limited access to traditional investors. However, once state and federal legislation was enacted, the industry’s interest rates decreased dramatically. There is much confusion with the terminology “discount rate” because the term is used in different ways. The discount rate referred to in a factoring transaction is similar to an interest rate associated with home loans, credit cards and car loans where the interest rate is applied to the payment stream itself. In a factoring transaction, the factoring company knows the payment stream they are going to purchase and applies an interest rate to the payment stream itself and solves for the funding amount, as though it was a loan.[citation needed] Discount rates from factoring companies to consumers can range anywhere between 8% up to over 18% but usually average somewhere in the middle. Factoring discount rates can be a bit higher when compared to home loan interest rates, due to the fact the factoring transactions are more of a boutique product for investors opposed to the mainstream collateralized mortgage transactions. One common mistake in calculating the discount rate is to use “elementary school math” where you take the funding/loan amount and divide it by the total price of all the payments being purchased.