The weighted average interest rate is calculated by multiplying each loan amount by its respective interest rate, summing the results, and then dividing by the total loan balance.
To understand this better, let's break it down:
Steps to Calculate Weighted Average Interest Rate
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Multiply each loan amount by its interest rate: This gives you the total interest cost for each loan, weighted by its size.
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Add the results together: This sums up the weighted interest costs for all loans.
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Divide that number by the sum of all your loan balances: This normalizes the total weighted interest cost by the total amount borrowed, giving you the weighted average interest rate.
Formula
The formula for calculating the weighted average interest rate is:
Weighted Average Interest Rate = ( (Loan 1 Amount * Loan 1 Interest Rate) + (Loan 2 Amount * Loan 2 Interest Rate) + ... + (Loan N Amount * Loan N Interest Rate) ) / (Loan 1 Amount + Loan 2 Amount + ... + Loan N Amount)
Example
Let's say you have two loans:
- Loan 1: \$10,000 at 5% interest
- Loan 2: \$20,000 at 7% interest
The calculation would be:
Weighted Average Interest Rate = (($10,000 * 0.05) + ($20,000 * 0.07)) / ($10,000 + $20,000)
Weighted Average Interest Rate = ($500 + $1400) / $30,000
Weighted Average Interest Rate = $1900 / $30,000
Weighted Average Interest Rate = 0.0633 or 6.33%
Therefore, your weighted average interest rate is 6.33%.
Why is this Important?
Knowing your weighted average interest rate gives you a single, overall view of the interest you are paying on your debts. This can be helpful for:
- Comparing different debt portfolios: Easily see which mix of loans has the lowest overall interest cost.
- Evaluating refinancing options: Determine if consolidating or refinancing your loans makes financial sense.
- Budgeting and financial planning: Get a clear picture of your total interest expenses.
In summary, calculating the weighted average interest rate provides a valuable metric for understanding and managing your overall borrowing costs.
