Weighted Average Coupon (WAC)

Definition

The weighted average coupon (WAC) is the average gross interest rate of the mortgages in a mortgage-backed security (MBS), weighted by each mortgage’s outstanding principal. It represents the coupon investors receive on the pooled mortgages at the time the security is measured and is commonly used to analyze prepayment behavior and expected cash flows.

Why WAC matters

• Indicates the average interest yield of the mortgage pool backing an MBS.
• Helps analysts estimate prepayment speeds, cash flows, and relative value.
• Changes over time as borrowers repay or prepay mortgages with different rates.

How WAC is calculated

WAC is the principal-weighted average of the underlying loan coupon rates:

WAC = (sum of (coupon rate_i × outstanding principal_i)) / (sum of outstanding principal_i)

Two equivalent ways to compute it:
1. Multiply each mortgage’s coupon rate by its remaining principal, add those products, then divide by the total remaining principal.
2. Compute each mortgage’s weight (its principal ÷ total principal), multiply each weight by the mortgage’s coupon, and sum the results.

Worked example

An MBS contains three mortgage pools with a combined principal of $11,000,000:
* Pool A: $4,000,000 at 7.5%
* Pool B: $5,000,000 at 5.0%
* Pool C: $2,000,000 at 3.8%

Method 1:
WAC = [($4,000,000 × 0.075) + ($5,000,000 × 0.05) + ($2,000,000 × 0.038)] / $11,000,000
WAC = ($300,000 + $250,000 + $76,000) / $11,000,000 = $626,000 / $11,000,000 = 5.69%

Method 2 (weights):
* Weights: 36.36%, 45.45%, 18.18%
WAC = (0.3636 × 7.5%) + (0.4545 × 5.0%) + (0.1818 × 3.8%) = 5.69%

Practical considerations

• WAC is a snapshot measure and will shift as loans amortize or are prepaid. Faster prepayments of higher- or lower-rate loans will move the WAC accordingly.
• Analysts use WAC alongside metrics like weighted average life (WAL) and prepayment models to value MBS and forecast cash flows.
• WAC does not by itself indicate credit quality; pools with similar WACs can have different risk profiles depending on loan seasoning, borrower credit, and documentation standards.

Risk context

Mortgage-backed securities played a central role in the 2007–2008 financial crisis. Many MBS at that time were backed by subprime or otherwise risky mortgages that defaulted when housing prices fell, demonstrating that a pool’s coupon rates (and WAC) do not capture borrower credit risk or underwriting quality.