How to Calculate the Cost of a Debt

Tax deductions can make your debt cost less.

Tax deductions can make your debt cost less.

The cost of debt allows you to compare the cost of various borrowing options to determine which is the best for you. The cost of debt can be measured either as the pretax cost or the after-tax cost. The after-tax cost of debt takes into account the tax benefits of the interest paid. For example, home mortgage interest is deductible, so the true cost of a mortgage is lower than the interest rate that you pay. To figure the cost of debt, you need to know how much you borrowed and how much interest you paid. If you want to also figure the after-tax cost, you need your tax rate.

Divide the interest paid by the amount borrowed to calculate the pretax cost of debt as a decimal. For example, if you've borrowed $150,000 and you paid $9,750 in interest, divide $9,750 by $150,000 to get 0.065.

Multiply the result by 100 to convert the pretax cost of debt to a percentage. In this example, multiply 0.065 by 100 to get 6.5 percent as your pretax cost of debt.

Divide your tax rate by 100 to convert it to a decimal if you can deduct your interest and want to calculate the after-tax cost of debt. For example, if your tax rate is 30 percent, divide 30 by 100 to get 0.3.

Subtract your tax rate as a decimal from 1.0. In this example, subtract 0.3 from 1.0 to get 0.7.

Multiply the result by your pretax cost of debt to calculate your after-tax cost of debt. Finishing the example, multiply 6.5 percent by 0.7 to find your after-tax cost of debt equals 4.55 percent.

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