The average outstanding balance is the average amount of money owed on a credit account over a period of time. It is calculated by adding up the outstanding balance on a credit account at the end of each day or billing cycle, and dividing it by the total number of days or billing cycles.
The average outstanding balance is an important financial metric that has several significant implications for borrowers, lenders, and creditors. Borrowers should monitor this balance carefully and manage their debt in a way that minimizes the impact of this metric on their finances.
The average outstanding balance is the amount of money that a borrower owes to a lender at a given point in time, which includes the principal amount borrowed plus any accrued interest or fees. It is typically calculated by taking the outstanding balance at the end of each billing cycle and averaging it over the period of time covered by the billing cycle.
The average outstanding balance can be an important factor in determining the total cost of a loan or credit card debt, as it affects the amount of interest that accrues over time. A credit balance or installment that is subject to an interest rate can indeed qualify as an average outstanding balance. This includes any loans, credit card balances, or other types of credit that have not been paid off in full and are accruing interest charges over time.
However, a credit balance or installment that is not subject to an interest rate, such as a savings account or a checking account with no overdraft protection, would not typically be considered an average outstanding balance. Instead, these types of accounts would be subject to different types of calculations, such as average daily balance or minimum balance requirements.
In general, an average outstanding balance is the average amount of money owed to a lender or creditor over a certain period of time, which includes both the principal amount borrowed and any interest or fees that have accrued. This calculation can be used to determine the cost of borrowing money or carrying a balance on a credit card and can be an important factor in financial planning and budgeting.
This is how it is calculated:
Let us look at a few examples to understand the concept better:
Let's say that John has a personal loan with a principal amount of $10,000 and an interest rate of 8% per year. The loan term is 36 months, and the payments are due monthly.
At the beginning of the loan, John's outstanding balance is equal to the principal amount, which is $10,000. The first month's payment is $312.94, which is calculated using a standard loan payment formula. Of this amount, $66.67 goes towards interest, and the remaining $246.27 goes towards reducing the principal balance.
At the end of the first month, John's outstanding balance is $9,753.73, which is the original balance of $10,000 minus the principal reduction of $246.27.
In the second month, John's payment is calculated using the same formula. But it is based on the new outstanding balance of $9,753.73. The payment amount is $312.94 again. But the interest portion is slightly lower at $64.78, and the principal portion is slightly higher at $248.16.
This process continues each month for the duration of the loan. John's balance decreases slightly with each payment until it reaches zero at the end of the 36-month term.
Let us calculate the average outstanding balance over the term of the loan. We need to add up John's outstanding balance at the end of each month and divide it by the number of months in the term (36, in this case). This would give us the average amount owed by John to the lender over the course of the loan. This also takes into account the interest charges that accrued each month.
For example, let's say we add up John's outstanding balance at the end of each month and get the following values:
End of Month 36: $0.00
Total outstanding balance = $345,569.15
Number of months in the term = 36
Average outstanding balance = $345,569.15 ÷ 36 = $9,599.15
So the average outstanding balance for John's loan over the 36-month term is $9,599.15. This value can be used to calculate the total amount of interest charged on the loan and to determine the monthly payments required to pay off the loan within the specified term.
Suppose that Jane has a credit card with a $5,000 credit limit and a 15% interest rate. She made a $2,500 purchase on the first day of her billing cycle and paid $500 on the 15th day. She then made another $1,500 purchase on the 20th day. The billing cycle lasts for 30 days.
Using the average daily balance method, the credit card company would calculate Jane's interest charges as follows:
At the beginning of the billing cycle, Jane's balance is $2,500.
For the first 14 days of the billing cycle, Jane's average daily balance is $2,500 (i.e., the balance remains unchanged).
On the 15th day, Jane makes a payment of $500, which reduces her balance to $2,000.
For the next 4 days, Jane's average daily balance is $2,000 (i.e., the balance remains unchanged).
On the 20th day, Jane makes another purchase of $1,500, which increases her balance to $3,500.
For the final 10 days of the billing cycle, Jane's average daily balance is $3,500.
The credit card company would then multiply the average daily balance by the daily interest rate to calculate the interest charges for the billing cycle.
Suppose that the daily interest rate is 15% / 365 = 0.041% per day. Jane's average daily balance for the billing cycle would be:
((14 x $2,500) + (4 x $2,000) + (10 x $3,500)) / 30 = $2,833.33
Her interest charges for the billing cycle would be:
$2,833.33 x 0.041% x 30 = $3.70
So Jane's interest charges for the billing cycle would be $3.70, which would be added to her balance if she did not pay off the full amount. If Jane continued to carry a balance on her credit card, her average daily balance would change each month, which would affect the amount of interest she would owe.
The average outstanding balance can indirectly impact the credit score by affecting credit utilization ratio. The credit utilization ratio is the percentage of the credit limit at any given time. It's an important factor in determining the credit score, as lenders consider high credit utilization to be a sign of risk.
If the average outstanding balance is high, it means they are using a large percentage of available credit. For example, if the person has a credit card with a $10,000 limit and an average balance of $8,000, the credit utilization ratio would be 80%. This high credit utilization ratio could lower the credit score.
On the other hand, if the average outstanding balance is low, they are using a smaller percentage of the available credit, which can have a positive impact on credit scores. For example, if the person has the same $10,000 credit limit but only has an average balance of $2,000, the credit utilization ratio would be 20%, which is considered a healthy utilization rate.
The average outstanding balance is an average representation of the amount owed over a specific period, while the total amount due represents the full payment required for a particular billing cycle or period. It provides insight into the account balance trend over time, while the total amount due indicates the immediate payment obligation.
2. What is the difference between the average outstanding balance and the remaining balance?The average outstanding balance provides an average representation of the amount a person owes over a specific period of time, while the remaining balance is the amount they still owe on an account after payment or transaction. The average outstanding balance focuses on the average balance over a period, while the remaining balance represents the current outstanding amount.
3. How to calculate the daily average outstanding balance?The formula for calculating the daily average outstanding balance can be written as:
Daily Average Outstanding Balance = (Total Outstanding Balance for the Period) / (Number of Days in the Period)
Calculating the daily average outstanding balance can be useful for understanding borrowing habits and how much interest is likely to pay on your loans or credit card balances. By keeping track of the daily average outstanding balance, an individual can make more informed decisions about when to make payments and how much to pay to minimize interest charges.
This article has been a guide to what is Average Outstanding Balance. Here, we explain how to calculate it, its examples, & effect on credit score. You may also find some useful articles here -
