How to Use This Tool
Enter your marginal tax rate as a percentage (the highest tax rate you pay on income). Select the compounding frequency for your debts, typically monthly for most personal loans and mortgages.
Add up to three debt accounts: enter the principal balance, annual interest rate, and indicate if the interest is tax-deductible (e.g., mortgage interest or student loan interest in some regions). Leave unused debt entries blank.
Click Calculate to see your detailed cost of debt breakdown, or Reset to clear all fields. Use the Copy Results button to save your summary to your clipboard.
Formula and Logic
The cost of debt calculation uses the following standard financial formulas:
- Annual Interest per Debt: Principal Amount × (Annual Interest Rate / 100)
- Total Pre-Tax Interest: Sum of annual interest across all valid debts
- Tax Savings: Total Tax-Deductible Interest × (Marginal Tax Rate / 100)
- Total After-Tax Interest: Total Pre-Tax Interest - Tax Savings
- Weighted Average Pre-Tax Cost of Debt: (Total Pre-Tax Interest / Total Principal) × 100
- Effective After-Tax Cost of Debt: (Total After-Tax Interest / Total Principal) × 100
Compounding frequency is reflected in the annual interest rate you enter, as most personal loan rates are already annual percentage rates (APR) that account for compounding.
Practical Notes
- Marginal tax rate is the rate you pay on your last dollar of income, not your effective average tax rate. Check your latest tax return for this value.
- Only enter tax-deductible debt if the interest is eligible for a tax deduction in your jurisdiction. For example, mortgage interest and some student loan interest may be deductible in the US, but rules vary by region.
- A lower after-tax cost of debt means cheaper borrowing. Use this to compare loan offers: a loan with a higher interest rate may have a lower after-tax cost if it is tax-deductible.
- Revolving debt like credit cards typically have higher interest rates and are not tax-deductible, which will increase your overall cost of debt.
Why This Tool Is Useful
Understanding your cost of debt helps you make informed borrowing decisions. It lets you compare the true cost of different loans, prioritize paying off high-cost debt first, and evaluate how tax deductions reduce your borrowing expenses.
Financial planners use cost of debt calculations to optimize client debt portfolios, while individual budgeters can use it to plan debt repayment strategies and avoid overleveraging.
Frequently Asked Questions
Is cost of debt the same as interest rate?
No, the interest rate is the percentage charged on a single debt, while cost of debt is the weighted average of all your debts after accounting for tax benefits. It reflects the true overall cost of your borrowing.
How do I find my marginal tax rate?
Your marginal tax rate is the highest tax bracket you fall into based on your taxable income. You can find this on your annual tax return, or check the current tax brackets published by your local tax authority.
Why is my after-tax cost of debt lower than pre-tax?
If you have tax-deductible debt, the government effectively subsidizes a portion of your interest payments via tax savings. This reduces the net amount you pay, lowering your effective cost of debt.
Additional Guidance
- Re-calculate your cost of debt annually or when you take on new debt to keep your figures up to date.
- If you have more than three debts, group smaller debts together by interest rate to simplify the calculation.
- Use this tool alongside a budget planner to ensure your debt payments fit within your monthly cash flow.