What is a Blended Rate?
A blended rate is an average interest rate between an old loan and a new loan. The rate is calculated in case a borrower receives an additional loan without fully repaying the previous one. Sometimes, the blended rate can be calculated when the old loan is being refinanced by originating two new ones.
Usually, lenders offer blended rates to allow borrowers to refinance their existing low-interest loans instead of giving them a chance to settle their obligations in full.
- A blended rate is a combination of interest rates on various loans that gives the total amount of interest on loans aggregated in one.
- Blended rates are usually used to determine the true interest rate paid when refinancing a loan.
- The calculation of blended rates is different for corporations and individuals.
How Do Blended Rates Work?
Blended rates are usually used to determine the true interest rate paid when refinancing a loan, but it can also be used when taking additional debt, i.e., obtaining a second mortgage. Blended rates are also used in the pooled cost of funds computation.
When the two compared term loans are the same, the combined rate is equal to the arithmetic mean of the two rates, based on the size of loans. However, if the term loans are not the same, the blended rate is first calculated using the annual interest rate for both loans.
For example, if a loan of $375,000 is refinanced by a mortgage of $300,000 at 6.5% interest rate, and a mortgage of $75,000 at 7.75% interest rate received for the same period, the blended rate will be calculated as ($300,000 * 6.5%) + ($75,000 * 7.75%) / $375,000 = 6.75%.
What is the Pooled Cost of Funds?
The pooled cost of funds is one of the possible ways of calculating the total cost of an institution’s capital. The pooled cost of funds refers to the costs incurred by the institution for attracting financing by obtaining loans and servicing them. Investors provide an institution with funds that would generate interest. The interest paid to investors on the invested capital offered on credit is called the cost of funds or the cost of capital.
The combined cost of funds takes into account the assets and liabilities of the organization as a whole. To determine the combined cost, divide the balance sheet into different categories of specific interest-bearing assets. The assets are then compared with the corresponding interest-bearing liabilities.
How is the Pooled Cost of Funds Calculated?
To calculate and determine the total cost of funds, interest-bearing assets and interest-bearing liabilities are compared using the same time horizon, also called the identical accounting period. The total cost of funds also takes into account the debit and credit of the business entity.
Example of Calculating Blended Rates
1. Corporate Debt
Some companies can incur more than one type of corporate debt. For example, if a company holds $100,000 in debt at a 4% interest rate and $170,000 in debt at a 10% interest rate, the total blended rate would be calculated as [($100,000 x 0.04) + ($170,000 x 0.1)] / ($100,000 + $170,000) = 7.77%.
A blended rate is also used in accounting for expenses by funds to quantify liabilities or investment income on the balance sheet. For example, if a company holds two loans, one for $2,000 at a rate of 10% and the other for $3,000 at a rate of 5%, and paid interest every month, then a loan of $2,000 after one year would be charged $200, and a loan of $3,000 would be charged $150. Therefore, there would be a blended rate: ($200 + $150) / $5,000 = 7%.
2. Personal Debt
Banks offer blended rates to keep customers and increase the loan amount for verified and creditworthy customers. For example, if a customer currently faces a 5% interest rate in a $100,000 mortgage and wants to refinance it when the current rate is 7%, the bank may offer a blended rate of 6%.
The borrower can then decide to refinance the $145,000 at a blended rate of 6%. He or she will still pay 5% of the original $100,000, but only 6% of the additional $45,000.
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