Perhaps the best way to explain a blended interest rate is to begin by explaining what it is not. It is not an average interest rate. That is, it is not determined by adding each interest rate and dividing by the number of interest rates (or, stated slightly differently, summing each interest rate and dividing by the number of loans).

Average Interest Rate

EXAMPLE #1:

In this example, 7.25% is in fact the average interest rate. However, this can be very misleading when it comes to making financial decisions based on this average. Let me explain. Let’s assume that the total of the three loans equals $100,000:

Illustrated below are monthly payments for a 30 year mortgage with various interest rates.

In this example, if you could get an interest rate of less than 7.25% for a loan amount of $100,000, presumably, this would result in wise financial decision. Example #1 assumes that any one of these lower than average interest rates would provide financial benefits for the borrower. However, consider the following:

EXAMPLE #2:

Example #2 shows the monthly payments for three loans that total $100,000. It helps illustrate that if an individual made a financial decision based on an average interest rate of 7.25% and refinanced their $100,000 in loans with an interest rate of 6.75%.........their monthly payment would not decrease at all. In fact, their monthly payment would actually increase from $642.57 to $648.60……clearly, not a wise financial decision. So how does one make a wise financial decision when faced with a variety of loan amounts with differing interest rates? The answer is to determine the “ blended interest rate”, then, seek an interest rate that is below the “blended interest rate”……..this will guarantee that you have made a wise financial decision.

Let me try to explain this concept using the above examples. The “ blended interest rate” takes into account the amount of each loan in relationship to the total amount of loans. The amount of total loans would be equal to 100% and the amount of each loan (if more than one) would be less than 100% but when all loans are totaled, they would equal 100%.

Blended Interest Rate

EXAMPLE #3:

BALANCE % OF DEBT First loan $ 70,000 (70,000/100,000) 70% Second loan 20,000 (20,000/100,000) 20% Third loan __10,000__ (10,000/100,000) __10%__ Total $100,000 100%

Once you have established this specific loan to total loan relationship, you then multiply that percentage by the interest rate for the specific loan. This number represents an interest rate factor and the summation of each of these factors equals the “ blended interest rate”.

Blended Interest Rate

EXAMPLE #4:

BALANCE % OF DEBT INT. RATE FACTOR First loan $ 70,000 70.00% 6.250% 4.375% Second loan 20,000 20.00% 7.250% 1.450% Third loan 10,000 10.00% 8.250% .825%   “ blended interest rate” 6.650%

Now then, given the “ blended interest rate” of 6.65%, if an individual can secure a lower rate, they would have made a wise financial decision. In fact, an interest rate of 6.50% for the loan amount of $100,000 would yield a monthly payment of $632.07 which is $10.50 lower than the existing payments for all three loans…….once again, a wise financial decision.

For those of you who would like to calculate your current blended interest rate, please go to Calculators on this web site and click on “Your Blended Interest Rate”.

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