The weighted average life (WAL) or average life reflects the average number of years required to pay off one unit of the principal on a loan, such as a dollar. In a 10 year loan with no interest and biweekly payments, for example, the WAL would be five years. However, most loans come with interest, and this is why it is referred to as a “weighted” average, reflecting the fact that some payments carry more weight than others when it comes to paying down the principal balance on the loan. Thus, something like a thirty year loan could have a weighted average life of 17 years or more, depending on the amount of interest.
To calculate the WAL of a debt, people look at the principal, the interest, and the repayment period. The amounts of the payments are also taken into account. Using this information, people can determine, on average, how long it takes to pay off a single dollar or other unit of currency. This information can also be used to find out how long it will take to pay down half the principal.
A number of things can skew the weighted average life. Some loans have unequal payments, with people paying more or less at the start of the loan period than they do at the end. Likewise, changes in interest rates can throw the calculation off. In addition, people can repay loans early, which will reduce the average life by paying off more of the principal with each payment. The basic calculation assumes that the payments will remain consistent as scheduled.
Calculating WAL is generally not as important to individual consumers, but it can be important for businesses. This can be used both to determine how payouts on the loans a business takes out will work, and how payments made on loans extended by the business will function. As can be seen when making calculations, the higher the interest rate, the higher the weighted average life.
It can be helpful to determine the WAL on a loan, especially when people are applying the loans. Another thing people may want to consider is interest paid over the life of the loan. As a general rule, it is better to pay more on a loan in the beginning and less in the end, if payments are going to be skewed, because this will pay the principal down quickly and reduce the average life in addition to the amount paid in interest over the life of the loan.