Calculating Student Loan Weighted Average Interest Rates

For students struggling to pay back their student loans, consolidating multiple federal loans into one can provide a single rate and payment and help lessen financial strain. However, Direct Consolidation Loans don’t guarantee borrowers the benefit of a lower interest rate.

To determine the interest on the new loan, the lender uses a weighted average of the interest rates on loans included in the consolidation. Understanding how to calculate a weighted average interest rate for student loans can help borrowers determine if consolidation is the best option.

What is a weighted average interest rate?

A weighted average interest rate is the average of the current interest rates on existing student loans, adjusted for how much you owe on each loan. This method is considered more accurate than the average of your interest rates because it considers discrepancies within your debt load.

In other words, if you owe only $1,000 at an extremely high interest rate and $10,000 at an extremely low interest rate, those rates won’t be weighted equally since the balance is much higher with one rate.

What loans use a weighted average interest rate?

Most federal loans, including the direct consolidation loan, use the weighted average rate. The interest rate of any loan a borrower rolls into their new Direct Consolidation loan is used in the calculation to determine the rate. Only federal loans are eligible for this type of consolidation loan, which may include Direct, Subsidized, Unsubsidized, PLUS, FFEL and Perkins Loans.

Borrowers may also consolidate through student loan refinancing, which does not use a weighted average interest rate. Instead, the lender determines the interest rate of the new loan based on current rates in the market, the borrower’s credit profile and whether the new loan has a fixed or variable rate.

Fixed interest rates remain the same for the life of the loan. Student loan refinancing is typically recommended for private student loans, not federal. That’s because you may lose benefits like income-driven repayment plans and forgiveness programs if you refinance your federal loans.

How to calculate a weighted average student loan interest rate

To determine the weighted average interest rate for your student loans, you’ll multiply each loan’s interest rate by the loan balance, then divide the sum by the total loan balance.

Let’s say you’re consolidating two loans. You owe $5,000 on one student loan at 5 percent and another $10,000 on a student loan at 3 percent. Your total debt is $15,000. Use the following steps to figure out the weighted average interest rate you would be eligible for:

Step 1: Multiply each loan balance by the corresponding interest rate for the loan.

• $5,000 x 0.05 = $250
• $10,000 x 0.03 = $300

Step 2: Add the products of these calculations together.

Step 3: Divide the sum of this calculation by the total debt load.

• $550/$15,000 = 0.0366666667

Step 4: Round this percentage up to the nearest one-eighth of a percentage point and multiply by 100.

The weighted average interest rate on this loan is 3.67 percent.

If the lender used the simple average of the two interest rates, the interest rate on the new loan would be 4 percent. This is why the weighted average interest rate is used for Direct Consolidation Loans instead of the actual average of all interest rates combined; the weighted average is able to take into account that the borrower owes twice as much money on the loan with the lower 3 percent rate.

If you don’t want to do the math on your own, simply search for an online weighted average student loan interest calculator.

How Direct Consolidation Loans affect your student loan payment

A Direct Consolidation Loan does let you modify your current federal student loans without getting a private lender involved. This means that you can qualify for federal student loan benefits like income-driven repayment plans, forgiveness programs and deferment or forbearance, if you’re eligible. A Direct Consolidation Loan will also lower your monthly payment, since your repayment will be stretched over a longer timeline.

However, you may pay considerably more interest on that extended timeline. That’s because you’ll pay interest for longer at a weighted average rate instead of your original loan rates.

There are other downsides to Direct Consolidation Loans, including the fact that any outstanding interest on the loans you consolidate becomes part of the original principal balance on your consolidation loan, meaning you’ll be paying interest on a higher loan balance. You may also lose out on perks like interest rate discounts, principal rebates and loan cancelation benefits, and any progress toward income-driven repayment plans or Public Service Loan Forgiveness may be reset.

How to lower your student loan interest rate

Consolidating your federal student loans through the federal program can provide several benefits, but a lower interest rate isn’t one of them. If you’re looking for opportunities to reduce your interest rate, here are a few to consider:

• Refinance your student loans: Depending on your credit history and income, you may be able to secure a lower interest rate than what you’re paying right now by refinancing your student loans with a private lender. If you can’t get a lower rate on your own, consider adding a co-signer to your application.
• Set up automatic payments: If you haven’t already, consider setting up autopay on your federal student loans. Most federal servicers offer a 0.25 percent discount on your interest rate if you get on an automatic payment plan.

If you decide to stick with your federal student loans, you may not be able to score a lower interest rate, but you can potentially reduce your interest charges by:

• Research forgiveness and repayment assistance programs to help you pay down your balance more quickly.
• Pay more than the minimum amount due every month.
• Use the debt snowball or avalanche method to tackle low-balance or high-interest loans.
• Pay half of your monthly payment every two weeks, so you end up making one full monthly payment yearly.
• Put your small windfalls, such as tax refunds, work bonuses and gifts, toward your student loans.
• Get an extra job or side hustle and put all that money into your loans.

Regardless of your approach, it’s important to take your time to understand all of your options and choose the path that works best for you.

Bottom line

When consolidating federal student loans, you can turn multiple loans into a single loan that only requires you to make one monthly payment. However, the interest rate may be determined through weighted average interest rates rather than simple average interest or other determining factors, like credit score. This may mean your interest rate will not necessarily improve after consolidating.