What is a Blended Rate?
The blended rate is the average interest rate of a new loan and an old loan. Why does this calculation take place? For instance, borrowers receive a new additional loan even when the previous loan is not yet fully paid.
Other cases involve two new and original loans refinance an old one. Why do lenders give out these blended rates? The reason is for borrowers to refinance their previous loans with low-interest rates rather than fully settling their obligations.
In short, a blended rate is a mixture of different loan interest rates equal to one sum of interest, thus having the name blended rate. On a loan refinancing, they determine the actual interest paid.
The use of blended rates
So now, when are blended rates used? When one determines an actual interest rate payment during a loan refinancing, obtains new debts like second mortgages, or computes the pooled cost of funds, they take action.
If two loans have the same terms and conditions, the combined rate will be equal to the mathematical means of two rates based on their sizes. In different loans, the blended rate initial calculation will use the loans’ annual interest rates.
Defining a pooled cost of funds
We’ve mentioned previously that blended rates are present in the computation of pooled cost of funds. A pooled cost of fund is a calculation of an entity’s costs to attract financing in the means of obtaining and servicing loans. Investors give entities funds to gain interests.
The interest that the entity pays back to the investor becomes the cost of funds, or as others call it, the cost of capital.
The total or combined cost of funds includes all assets and liabilities. How is the combined cost determined? The entity should divide all assets that incur different interest in the balance sheet then compare them to the assets that incur different liabilities.
Calculation of pooled cost of funds
The identical accounting period calculates the combined cost of funds where there is a comparison of assets that incur liabilities and assets with the debits and credits.
Examples of blended rates
Blended rates may pertain to debts of corporates and debts that individuals take or personal loans. The calculation of blended rates is getting the average of the loans’ interest rates.
Let’s say, a company incurred two debts. The first debt is $500,000 with a 10% interest rate and $200,000 debt with a 12% interest rate, the calculation of the blended rate would be something like this: [($500,000 x 0.1) + ($200,000 x 0.12)] / ($500,000 + $200,000)
In other scenarios, banks offer these blended rates so that customers will stay. The creditworthy clients will receive an increased loan amount once verified.
Let’s say a client has a 6% interest rate in a mortgage amounting to $100,000. However, the bank’s current rate at the moment is 8%. So, the client wants to refinance. Later on, the bank can give that client a 7% blended after verifying the creditworthiness.