While the term "weighted ROI" typically refers to calculating the return across multiple investments, where each investment's return is weighted by its proportion of the total portfolio value, the specific information provided details a method for calculating a different type of weighted average: the weighted average interest rate for multiple loans.
Based on the provided reference, here is how you calculate the weighted average interest rate for loans:
The calculation for a weighted average interest rate on multiple loans involves considering both the interest rate and the balance of each loan. This method gives more weight to the loans with larger balances, reflecting their greater impact on the overall cost of debt.
Here are the steps based on the reference:
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Multiply Each Loan's Interest Rate by its Loan Balance: For every individual loan, take its specific interest rate (usually expressed as a decimal) and multiply it by the current outstanding balance of that loan.
- Example: Loan A: 5% (0.05) interest rate, $10,000 balance. Product: 0.05 * $10,000 = $500.
- Example: Loan B: 7% (0.07) interest rate, $20,000 balance. Product: 0.07 * $20,000 = $1,400.
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Sum the Products: Add up the results obtained from multiplying the rate by the balance for all the loans you are considering.
- Example: Sum of products = $500 (from Loan A) + $1,400 (from Loan B) = $1,900.
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Sum the Total Loan Balance: Calculate the total outstanding balance across all the loans.
- Example: Total Loan Balance = $10,000 (Loan A) + $20,000 (Loan B) = $30,000.
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Divide the Sum of Products by the Total Loan Balance: This final division gives you the weighted average interest rate.
- Example: Weighted Average Interest Rate = $1,900 / $30,000 = 0.06333... or 6.33%.
This calculation method ensures that "Each loan's interest rate contributes to the weighted average in proportion to the loan's percentage of the total debt."
Here is a simple example illustrating the calculation:
| Loan | Balance | Interest Rate | Rate * Balance |
|---|---|---|---|
| Loan 1 | $100,000 | 4% (0.04) | $4,000 |
| Loan 2 | $50,000 | 6% (0.06) | $3,000 |
| Total | $150,000 | $7,000 |
Weighted Average Interest Rate = (Sum of Rate * Balance) / (Total Balance)
Weighted Average Interest Rate = $7,000 / $150,000 = 0.04667 or 4.67% (approx.)
Why is this calculation important?
Understanding the weighted average interest rate provides a single figure that represents the overall cost of your debt portfolio, weighted by the amount borrowed at each rate. This is particularly useful for:
- Comparing the overall cost of different debt structures.
- Evaluating the impact of taking on new debt at a different rate.
- Financial planning and budgeting related to interest expenses.
In summary, based on the provided reference, the method described is for calculating the weighted average interest rate on loans by weighting each loan's rate by its balance relative to the total debt.
