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When it comes to loans and mortgages, a change in interest rates is not a very uncommon thing.
This can happen due to several reasons such as economic factors, market trends, and policies of lending institutions. When this happens, the interest rate of your loan may also change.
Blended rate is a term used to describe a new interest rate that is calculated when there is a change in the original interest rate of a loan. By understanding blended rates, it will be easier to manage loans and make informed financial decisions.
What is the Blended Rate?
Blended loans refer to loans that carry an interest rate formed by combining an existing rate and a fresh rate. This type of loan is commonly seen in both corporate debt refinancing as well as consumer loans like revamped mortgages.
The calculation of the blended rate usually involves determining the weighted average of the interest rates on the loans.
In simple words, a blended loan merges old and new interest rates to create a unique rate for the borrower. It’s a straightforward concept, often used to simplify repayment or adjust to new financial circumstances.
How Blended Loans Work
Blended loans work by combining an existing loan’s interest rate with a new rate, forming a unique blended rate. When a borrower wants to refinance a loan, instead of completely replacing the old rate, a new rate is added.
The resultant blended rate is computed using a weighted average of the original and new rates. This method is commonly employed in situations like corporate debt refinancing or consumer loans, such as revamped mortgages.
The main goal is to create a more manageable repayment structure that accounts for changes in financial circumstances while maintaining simplicity in understanding and calculation.
Calculating the Blended Rate
Let’s say a business has two different types of debt. One is for $150,000 at an interest rate of 5%, and the other is for $200,000 at a rate of 9%.
To calculate the blended rate, first multiply each debt amount by its respective interest rate
($150,000 x 0.05) and ($200,000 x 0.09). Then add these two amounts together.
The result is divided by the total debt amount, which is $350,000 in this case.
The calculation looks like this: [($150,000 x 0.05) + ($200,000 x 0.09)] / ($150,000 + $200,000) = 7.29%. This figure represents the blended interest rate for the total debt.
In personal loans, blended rates are a tool used by financial institutions to retain clients and potentially increase the loan sum for reliable, creditworthy individuals.
For instance, consider an individual with a $80,000 mortgage at a 4% interest rate. If they decide to refinance when the current market rate is 6%, the bank might propose a blended rate of 5%.
The borrower then has the option to refinance the expanded $120,000 loan at this 5% blended rate. The original $80,000 portion of the loan would maintain its 4% rate, while the extra $40,000 would be subject to the new 5% rate.
This approach allows borrowers to take advantage of both existing and new rates in a way that could be more financially beneficial for them.
Conclusion
Debt is one of the biggest drives of financial decisions in both personal and business life. Understanding various aspects of debt, such as interest rates and blended rates, can help individuals and businesses make informed decisions when it comes to managing their finances. Blended rates are a useful tool for calculating the overall interest rate for multiple debts, making it easier to budget and plan for debt payments. By knowing how to calculate blended rates and being aware of their potential benefits, individuals can make the most out of their loans and financial situations.
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