What Is the Average Balance?
The average balance is the account balance calculated over a chosen period of time-based upon multiple closing balances over that period of time. Averages are most commonly calculated on a daily or monthly basis.
- The average balance is the average amount of money held in an account, or due, over a set period of time.
- Average balances are usually calculated daily or monthly, with the average daily balance being the standard for how credit card companies calculate interest charges.
- Average monthly balances are used by banks in deposit accounts and by creditors to assess stability with income and spending.
How the Average Balance Works
Average daily balance is most commonly used by credit card companies in calculating a monthly finance charge. The interest rate is multiplied by the average daily balance. Average monthly balance is commonly used by banks to determine whether or not a client meets account balance minimums to avoid being charged account fees.
Creditors use the average monthly balance to assess a borrower's income stability when assessing loan eligibility. Large fluctuations in average monthly balances of bank accounts can signal an inconsistent income stream or big swings in spending habits. These are things that potential lenders can view as risky.
Types of Average Balances
An average daily balance adds the closing balances at the end of each day in a given period of time and divides the sum by the number of calendar days in that period.
An average monthly balance sums the closing balance at the end of each day and divides it by the number of calendar days in the month.
A simple average balance between a beginning and ending date is calculated by dividing the beginning balance plus the ending balance by two.
Average Balance Example
An example of average daily balance is exhibited with credit cards. By law, credit card companies must show how they calculate finance charges. Thus, to charge interest “daily” credit card companies must show their calculation of your average daily balance.
For example, you have a $1,000 balance on your credit card as of Jan. 1. On Jan. 10 you make a $400 purchase. Your payment is due on Jan. 18 and you make a $700 payment. Then on Jan. 25, you make a $1,000 purchase, followed by a $500 payment on Jan. 28.
Your average daily balance for the month of January is:
$1,000 * 10 days (Jan. 1-10) = $10,000
$1,400 * 8 days (Jan. 10-18) = $11,200
$700 * 7 days (Jan. 18-25) = $4,900
$1,700 * 3 days (Jan. 25-28) = $5,100
$1,200 * 3 days (Jan. 28-31) = $3,600
You multiply all these balances and then take the sum and divided by the number of days in your period—in this case, 31 days in the month of January. The average daily balance of the above example is $1,122.58 ($34,800 / 31).