Understanding Weighted Average –

Example: a student has Stafford Loans originated on or after July 1, 2006. These loans have a fixed interest rate of 6.8%. If they are consolidated by themselves, the consolidation loan will have an interest rate of 6.875%. The interest rate increases slightly because the consolidation calculation requires that the weighted average is rounded up to the nearest one-eight of one percent.

With a mix of loans with different interest rates, the weighted average will be somewhere in between. For example with a $5,000 of Perkins Loans (at 5.0%) and $10,000 of Stafford Loans (at 6.8%), the weighted average is calculated as follows:

$5,000 * 5.0% = $250

$10,000 * 6.8% = $680

$930

$930 / $5,000 + $10,000 = 6.2%

This weighted average, 6.2%, is then rounded up to the nearest 1/8th of a percent, yielding a consolidation loan interest rate of 6.25%.

The weighted average does not fundamentally alter the underlying cost of the loan. It preserves the cost structure by including each interest rate to the extent that it applies to part of the overall loan balance. For example, the consolidation loan in the previous paragraph says that of the $15,000 consolidation loan balance, $5,000 will be at 5.0% and $10,000 at 6.8%, yielding an equivalent interest rate of 6.2%.

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