The interest rate is one of the most critical pieces of information in evaluating a loan pool. But taking the weighted-average coupon (WAC) at face value can be strikingly misleading. Unless all loans share the same rate or remaining term, using WAC as a constant rate will likely understate the pool’s future interest rate and returns.
A two-loan example
Take two equal loans: a 4% loan with 24 months left and a 6% loan with 60 months left. The starting WAC is 5%. The shorter, lower-rate loan pays down faster, so WAC drifts up, slowly at first and then faster, to 6% by month 24. At par, the pool’s blended IRR is 5.41%, well above the starting 5% WAC.
This is the common case, not the exception
Longer-term loans generally carry higher rates for a given credit box. After a rise in rates, seasoned loans with shorter remaining terms also tend to carry lower rates. Be alert to the opposite too: a seller could include many short-remaining-term, higher-rate loans, which would overstate future interest if you model the pool as one loan at its WAC.
A real pool
A real 1,400-loan pool had rates from 1.89% to 11.74% and remaining terms from 6 to 82 months. Its WAC was 4.70%, but WAC rose steadily over time. A loan-level IRR came to 5.98%, or 5.82% at a 15 CPR.
The fix: BRTWAC
If loan-level analysis is too complex, weight each loan’s rate by balance × remaining term instead of balance alone. This balance-remaining-term WAC (BRTWAC) captures how long each loan contributes interest. For the two-loan example, BRTWAC is 5.43% versus a 5.41% IRR. For the real pool, it’s 6.04% versus 5.98% (0 CPR) and 5.82% (15 CPR). There’s no substitute for loan-level analysis, but BRTWAC is far closer than WAC.