Understanding Blended Interest Rates
A blended interest rate is a weighted average of the interest rates on two or more separate loans. It represents the single, combined interest rate you would be paying if all your debts were consolidated into one. This concept is most commonly used in mortgage refinancing, especially when a borrower combines an existing mortgage with a new one (like a second mortgage or HELOC) without fully replacing the original loan.
The Formula for a Blended Rate
Calculating a blended rate involves finding the weighted average of the individual interest rates. The "weight" of each loan is its principal balance.
Blended Rate = [ (Loan A Balance × Loan A Rate) + (Loan B Balance × Loan B Rate) ] / (Loan A Balance + Loan B Balance)
This formula can be extended to include any number of loans. The calculator automates this process, giving you a quick and accurate blended rate.
Practical Examples
Example 1: Mortgage Refinance with a Second Loan
Suppose you have an existing mortgage with a $200,000 balance at a great rate of 3.0%. You need to borrow an additional $50,000 for a home renovation, and the best rate you can find for a second mortgage is 7.0%. Instead of refinancing the entire $250,000 at a new, higher market rate (say, 5.5%), you can keep your first mortgage and take out the second.
Using the calculator, you can find your blended rate:
- Loan A: $200,000 at 3.0%
- Loan B: $50,000 at 7.0%
- Total Debt: $250,000
- Blended Rate: 3.8%
By keeping the first low-rate mortgage, your combined interest rate is only 3.8%, which is significantly better than refinancing the entire amount at 5.5%. This is often called a "blend and extend" strategy.
Example 2: Consolidating Personal Debts
Imagine you have two outstanding debts:
- A personal loan with a $5,000 balance at 8% APR.
- A credit card with a $3,000 balance at 18% APR.
You are considering a debt consolidation loan. Before you shop for rates, you can calculate your current blended rate to establish a baseline. Your blended rate on the $8,000 total debt is 11.75%. This tells you that any consolidation loan with an APR lower than 11.75% will save you money on interest.