A blended interest rate is a combination of interest rates for different loans that gives the total amount of interest on the loans collected into one. This can give you a sense of what a person or company is paying on its total debt and is used in certain formulas, such as calculating the interest rate on consolidated student loans. Rates can't just be averaged together since they need to be weighted by the size of each loan.
When to Blend Interest Rates
Imagine that you have multiple credit card balances and want to figure out the overall rate you're paying on your credit cards or you have a first and second mortgage on your home and want to figure out an overall rate you're paying on home loans. Essentially, you want to know the total interest on these outstanding loans divided by the total principal, effectively computing the interest rate as if it were being calculated on one, big loan.
Blended interest rates are also used if you are consolidating student loans under a federal program and in certain types of corporate accounting. For instance, you might want to know the total effective rate a company is paying on its corporate debt, even though it might have many outstanding loans of different amounts and sizes.
Calculating Blended Interest Rates
The blended interest rate for a set of loans is the total amount of interest paid per year divided by the total principal. You can compute the interest paid per year by using the interest rates of the individual loans.
For example, if you have one $50,000 loan at 4 percent interest and one $100,000 loan at 3 percent interest, you can find the annual interest paid on each by multiplying the rate by the total loan amounts. That is, $50,000 * 4 percent = $50,000 * 0.04 = $2,000 and then $100,000 * 3 percent = $100,000 * 0.03 = $3,000 in interest, so the total interest paid is $5,000. The total principal is $100,000 + $50,000 = $150,000, so the total interest rate is $5,000 / $150,000 = 0.03333 = 3.33 percent.
You can treat bank accounts essentially as a loan from you to the bank, finding the blended rate between accounts by summing the account balances and interest in the same manner or use a blended rate savings calculator tool to find your blended rate on your bank balances.
Note that if you have two loans with the same interest rate, you do not need to compute a blended interest rate, since the blended interest rate will always simply be the rate of the two loans. You can use an online blended interest rate calculator or blended rate savings calculator to figure out your blended rate or do it by hand.
Working With Additional Loans
Note that the blended interest rate is among the total loan amounts. If you have additional loans, you can use the same process, dividing the total interest payment by the principal, summing across each of the loans.
For instance, if you have those same two loans plus a third loan for $200,000 at 5 percent interest, you would sum up $50,000 * 4 percent + $100,000 * 3 percent + $200,000 * 5 percent = $50,000 * 0.04 + $100,000 * 0.03 + $200,000 * 0.05 = $15,000 in total annual interest. The total principal is $100,000 + $50,000 + $200,000 = $350,000, so the total blended interest rate is $15,000 / $350,000 = 0.04286 = 4.29 percent interest. Logically, adding the additional higher interest loan raises the total blended interest rate.
Changing Interest Rates and Principals
If you have a portfolio that includes some loans with variable rates, like variable rate mortgages or credit cards, you will need to re-compute the blended interest rate of the portfolio when one of the rates changes. Additionally, as you pay back loans or potentially borrow more money, you may want to re-compute your total blended interest rate to get a more accurate picture of your total debt.