To calculate the weighted average interest rates of a set of loans, divide the total interest paid per year by the total balance on the loans. This can give you a good handle on how much you are paying overall in terms of loan interest and give you a sense of your overall rate. They're also used in certain corporate accounting procedures and can be used to determine the rate for a consolidated loan. You can calculate the weighted average, or blended, interest rate by hand or use a weighted average interest rate calculator tool.
Understanding the Average Interest Method
If you have a number of loans and want to understand the total interest rate across them, you will calculate the weighted average, or blended, interest rate of the loans. This gives you a sense of what you are paying in total in terms of interest rate on all of your debt. You might use this method to compute a total effective interest rate for a first and second mortgage, for multiple credit cards or for several student loans. Companies also sometimes use weighted average interest rates to report the total overall effective interest rate they are paying, since it is common to have companies with a variety of outstanding loans of various sizes.
You can also use the method to figure out the weighted average rate of return you are getting across several interest-paying investments, such as bonds or bank accounts. This is also useful if you are considering consolidated loans. You will generally save money if you can consolidate multiple loans to one with a lower interest rate than the weighted average of the initial loans.
Computing the Weighted Average Interest
To calculate the weighted average of two loans, sum up the total amount of interest paid on them in a year and divide it by the total outstanding balance on the loans. You can find the total amount of interest paid using the outstanding balance and the interest rate.
For example, imagine that you have a loan for $50,000 at 2 percent annual interest and a loan for $100,000 paying 4 percent annual interest. First, calculate the total amount of interest you pay on the two loans every year. This is ($50,000 * 0.02) + ($100,000 * 0.04) = $5,000. Then, you will divide this number by the total balance, which is $50,000 + $100,000 = $150,000 to get $5,000 / $150,000 = 0.0333 = 3.33 percent interest rate.
Note that if you have two loans with the same interest rate, the weighted average interest rate is always that interest rate, so there is no need to compute it separately.
Working with Additional Loans
If you have additional loans, the same logic applies. For example, assume that in addition to those two loans you have a loan for $200,000 at 5 percent interest. Sum up the total interest paid per year, which is equivalent to ($50,000 * 0.02) + ($100,000 * 0.04) + ($200,000 * 0.05) = $1,000 + $4,000 + $10,000 = $15,000.
Then, sum up the total balance, which is $50,000 + $100,000 + $200,000 = $350,000. Divide to get $15,000 / $350,000, or roughly 4.29 percent. Unsurprisingly, adding an additional loan at a higher rate skewed the weighted average higher.
Changing Rates and Balances
If you are computing weighted average interest rates, including loans with variable rates such as credit cards or variable rate mortgages, you may want to re-compute the weighted average after the rate changes.
Similarly, as you pay down a loan or borrow new money, you may want to re-compute your weighted average interest rates so that they reflect your current financial situation. Simply re-apply the formula with your current rate and balance information to get the new weighted average interest rate.