# How to Calculate the Cost of Debt

Trying to calculate the cost of debt?

Being in debt is never easy. Whether you’re struggling with student loans or walking a tight rope with credit cards, being in debt can cost you a LOT. In order to help you make your life a little less stressful, here is a breakdown of how to calculate the cost of debt.

## What Exactly IS the Cost of Debt?

There is a cost to being in debt! The cost of debt is the rate at which an individual, or even a company, pays down debt. Basically, taking into account after-tax costs of debt, as well as interest paid. After taxes are taken out, you can determine the interest expenses that are deductible, like valuable above the line deductions!

Basically, this means that the cost of debt is the return someone has for creditors, as well as debt holders. If someone has lent money to another individual, it is essentially the capital compensated for risks. All in all, it is money owed before taxes, after taxes, and after investments.

## Why Calculate the Cost of Debt?

Breaking down the cost of debt for anyone is so much easier than finding out your cost of equity. It is a more straightforward approach to finding out an individual’s worth Essentially, it can show the default risk and the level of interest rates for anyone.

Calculating the cost of debt is also a critical component of determining your WACC. For individuals, it can also mean finding where you can afford to save, invest, as well as dramatically decrease your debt.

## Calculating the Cost of Debt: Need to Know Information

There are several factors that go into calculating the cost of debt. However, in order to calculate this number you need two important factors. The marginal tax rate and the effective interest rates paid.

### Effective Interest Rates

Finding the effective interest rate that you pay on your debt is simple. You divide the annual interest by the total amount of debt owed and then multiply it by one hundred.

### Marginal Tax Rates

Marginal tax rates are the tax rates people pay for both federal and state combined. Here is a break down of the tax brackets in the US:

• 10% tax rate means a taxable income of \$0 to \$9,700
• 12% tax rate means a taxable income of \$9,701 to \$39,475
• 22% tax rate means a taxable income of \$39,476 to \$84,200
• 24% tax rate means a taxable income of \$84,201 to \$160,725
• 32% tax rate means a taxable income of \$160,726 to \$204,100
• 35% tax rate means a taxable income of \$204,101 to \$510,300
• 37% tax rate means a taxable income of \$510,301 or more

There are of course other stipulations. Taxes owed, as well as deductions can make a difference in your federal tax rate.

State income tax rates vary from state to state. However, they are not typically over 12%.

The cost of debt can then be calculated from these two sets of information! All in all, calculating the cost of debt is essentially multiplying the effective interest rate by the one minus the marginal tax rate.

#### Example of How to Calculate the Cost of Debt for You!

When it comes to calculating the cost of debt, it is best to put it into simple math. Instead of tracking your net worth, sit down and track your own cost of debt!

If you make \$100,000 a year and pay 24% federal taxes, then 5% in state taxes, your marginal tax rate is 29%. Your debt is paid at an effective interest rate of 7%. There fore, your cost of debt is as follows:

Cost of debt = 7% x (1-29%). 0.07 x (1-0.29) = 0.049. This means your personal cost of debt would be 4.9%!

### Uses for Cost of Debt

Now that you are aware how to calculate the cost of debt for yourself, WHY it is important to do this, as well as what variables you need to know beforehand you’re able to look into your company’s credit situation.

Once it is clear that your debt is at a minimal percentage against the size of your net worth, you can understand where you stand with creditors and your debt more accurately!

## Knowing How to Calculate the Cost of Debt

This information is not only vital to the outward success of your personal finances, but also to your personal success! Now that you know how to calculate your cost of debt, you can successfully create a clear financial picture for your future!