Weighted Average Interest Rate
The Weighted Average Interest Rate is the average rate of interest on multiple loans or financial products that takes into account the amount of each loan in the calculation. In other words, it gives you an average interest rate that considers not just the interest rate of each individual loan or credit line, but also the proportion of total debt that each loan represents.
Formula to Calculate Weighted Average Interest Rate:
$$ \text{Weighted Average Interest Rate} = \frac{(R_1 \times A_1) + (R_2 \times A_2) + \ldots + (R_n \times A_n)}{A_1 + A_2 + \ldots + A_n} $$Where:
- R1, R2, …, Rn are the interest rates for each individual loan or credit line.
- A1, A2, …, An are the amounts for each individual loan or credit line.
Example of Weighted Average Interest Rate
Here’s a simplified example to illustrate the concept of a weighted average interest rate.
Suppose you have three different loans:
- Student Loan: $25,000 at 5% interest
- Car Loan: $15,000 at 3% interest
- Personal Loan: $10,000 at 7% interest
Steps to Calculate the Weighted Average Interest Rate:
Step 1: Multiply the Amount of Each Loan by Its Interest Rate
- Student Loan: $25,000 x 0.05 = $1,250
- Car Loan: $15,000 x 0.03 = $450
- Personal Loan: $10,000 x 0.07 = $700
Step 2: Sum Up These Values
$1,250 (Student Loan) + $450 (Car Loan) + $700 (Personal Loan) = $2,400
Step 3: Add Up the Total Amount of All Loans
$25,000 (Student Loan) + $15,000 (Car Loan) + $10,000 (Personal Loan) = $50,000
Step 4: Calculate the Weighted Average Interest Rate
Weighted Average Interest Rate = $2,400 / 50,000 = 0.048 or 4.8%
Summary:
The weighted average interest rate for these loans would be 4.8%. This gives a more accurate picture of your average borrowing cost than simply averaging the individual interest rates, as it takes into account the size of each loan relative to the total amount borrowed.
By knowing the weighted average interest rate, you can better evaluate opportunities for loan consolidation or other financial strategies that could lower your overall interest payments.
