For federal consolidation loans, interest is done on a weighted average rounded up to the nearest 1/8%. As a result it can cause your overall loan to pay a little more or a little less. The average will be skewed towards whatever the interest rate is for the higher balance loans.
We will go over the formula and some examples to see if there is a yearly interest savings.
The calculation is as follows:
- (Loan Amount) X (Interest Rate) = Per Loan Weight Factor
- Repeat for each loan.
- Add Per Loan Weight Factors together.
- Add Loan Amounts together.
- (Total Weight Factors) / (Total Loan Amounts) = Weighted Interest Rate
- Round the Weighted Interest Rate up to the nearest 0.125%.
- Multiply Weighted Interest Rate by 100 to convert from a decimal to a
Let us use some easy examples. You have three loans:
One loan is 6,000 dollars at 4.5%
One loan is 3,000 dollars at 6.8%
One loan is 1,000 dollars a 3.2%
I will do the math on the first one to give you a visual:
$6000 x .045 (you convert percentage by moving decimal place to spots)=270
$3000 x .068= 204
$1,000 x .032=32
You add up all the dollar amounts ($10,000) and all the numbers you received after multiplying (506). You then divide the second number by the first (just remember to also divide by bigger number). 506 divided by 10000 is .0506. The weighted interest rate rounded up will be 5.125%
Now lets compare to see if changing the interest rates, changes the outcome:
The daily interest previously was $1.39* daily whereas the daily interest now is $1.40. In this scenario you would pay more daily interest by consolidating.
*Remember when figuring out daily interest you take the interest rate for each loan multiplied by the balance and divided by 365.
Let’s see what happens when you have more money at the lower interest rate:
One loan is 6,000 dollars at 3.2%
One loan is 3,000 dollars at 4.5%
One loan is 1,000 dollars a 6.8
After rounding the weighted interest rate is 4.00%. Your daily interest is $1.10. The previous daily interest is $1.08. Again in this scenario daily interest is a few pennies more. However there are situations where this may not be the case. You need to use the formulas given in order to decide if based on interest rate, consolidation is right for you.
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