Average Balance: Definition, How It's Used and Impact on Interest

What Is Average Balance?

The average balance is the balance on a loan or deposit account averaged over a given period, usually daily or monthly. The daily or monthly average balance is calculated using multiple closing balances over the selected period of time.

A simple average balance between a beginning and ending date is calculated by adding the beginning balance and the ending balance together, then dividing that amount by two.

How Average Balance Is Used

Average daily balance is most commonly used by credit card companies to calculate monthly finance charges. To find your average daily credit card balance, add the total balance due at the end of each day in a given period of time, and then divide the sum by the number of calendar days in that period. The interest rate on the credit card is then multiplied by your average daily balance.

Average monthly balance is commonly used by banks in order to determine whether or not a client is meeting required account balance minimums (and can avoid being charged a fee for not meeting the minimum). An average monthly balance takes the closing balance at the end of each day and divides it by the number of calendar days in the given month for its calculation.

Creditors use the average monthly balance to assess a borrower's income stability when assessing loan eligibility. Large fluctuations in the average monthly balance of bank accounts can signal to a creditor that a borrower has an inconsistent income stream or has volatile spending habits. These factors may lead a creditor to deem an applicant a risky borrower.

For investors who trade on margin accounts, the average balance may be used to determine margin requirements, or any margin calls that the brokerage makes.

Average Balance Example 

This is an example of how credit card companies calculate average daily balance. By law, credit card companies must show how they calculate finance charges. Thus, to charge interest “daily,” credit card companies must show how they calculate your average daily balance. 

Assume you have a $1,000 balance on your credit card as of January 1. On January 10, you make a $400 purchase. Your payment is due on January 18, and you make a $700 payment. Then on January 25, you make a $1,000 purchase, followed by a $500 payment on January 28. 

Your average daily balance for the month of January is: 

$1,000 * 9 days (January 1 to January 9) = $9,000

$1,400 * 8 days (January 10 to January 17) = $11,200

$700 * 7 days (January 18 to January 24) = $4,900

$1,700 * 3 days (January 25 to January 27) = $5,100

$1,200 * 4 days (January 28 to January 31) = $4,800

To calculate average daily balance, take the sum of all these ending balances and divide by the number of days in your period. In this example, there are 31 days in the month of January. The average daily balance of the above example is $1,129.03 ($35,000 / 31).