Weighted average loan maturity refers to when, on average, a portfolio of loans will come due. The higher the weighted average maturity or WAM, the longer it takes for all the mortgages to mature. A weighted average differs from a simple arithmetic average, however. When calculating a weighted average figure, the bigger loans have greater weights. This better represents the amount of time that must pass before you will receive or pay out each average dollar. A weighted average loan maturity is equally helpful whether you are the borrower or the lender.
Find the weighted average of each loan. To do so, add up the value of all the loans. Then divide each loan amount by the sum of all loans. Assume you took out three loans, in the amounts of $3,000, $5,000 and $12,000. The sum of the loans equals $20,000. Their weights are $3,000/$20,000 = 0.15; $5,000/$20,000 = 0.25; and $12,000/$20,000 = 0.6. To double-check the calculation, add up all the weights and make sure their sum is 1, which should always be the case. Here, the sum of 0.15 + 0.25 + 0.6 equals 1, telling us we are on the right track.
Multiply the number of years remaining for full repayment of each loan by its weight. Assume that the first loan of $3,000 is due in 10 years, the $5,000 loan is due in eight years and the final loan of $12,000 is due next year, in exactly 12 months. So we get 10_0.15 = 1.5, 8_0.25 = 2 and 1*0.6 = 0.6.
Add up the figures you have calculated in Step 2 to arrive at the weighted average loan maturity. In this example, the weighted average maturity is 1.5 + 2 + 0.6 = 4.1 years. Of the three loans, one is due in a decade, while the other is due in eight years. However, the loan that matters the most, the $12,000 loan, is due in one year. The weighted average maturity is therefore a surprisingly short 4.1 years. In other words, the loans mature in 4.1 years, if their dollar values are taken into account.
Investments such as mutual funds also make weighted average maturities available to fund managers and investors. These can be as little as three years or as long as 30 years. Publishing the WAM helps investors to choose a fund that matches his or her investing time frame.
Failing to consider the weights and merely adding up 10, eight and one and dividing the result by three – by using the arithmetic average – results in 6.3, which differs significantly from the weighted average figure.
- Failing to consider the weights and merely adding up 10, eight and one and dividing the result by three -- by using the arithmetic average -- results in 6.3, which differs significantly from the weighted average figure.
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