The average outstanding balance is the amount owed to a lender, including the balance after the last monthly payment and any interest accrued over time – usually after a month.
A credit balance or installment that is subject to an interest rate qualifies to be an average outstanding balance. It includes only an average amount of loans that clients have not settled or savings that clients have not withdrawn over a period.
Although the average outstanding balance serves many functions, it is mainly used as an instrument to evaluate interest on the debt. The type of average outstanding balance methodology employed determines the amount of interest to be paid by a client.
Average outstanding balance is a technique used by credit issuers to determine the outstanding loan portfolio.
The average outstanding balance is generally calculated daily but can also be calculated on a monthly or an annual basis.
While average outstanding balances are reported to credit reporting agencies to determine borrowers’ credit scores, it does not qualify as part of credit scoring methodologies.
Calculating Interest Using Average Outstanding Balances
A majority of credit card issuers calculate interest on revolving credit card loans using an average daily outstanding balance approach. A revolving credit card loan is the debt given after the last monthly repayment. As cardholders pay for purchases throughout the month, they accrue outstanding credit card balances.
Credit card providers use the average daily outstanding balance method to come up with slightly higher interest rates that not only factor into the credit card user’s balances in a period but also at the closing date.
A credit company can use average daily outstanding balance calculations to evaluate interest daily by compiling the average of the balances over the last month.
In most cases, credit providers obtain the average daily balance interest by multiplying the evaluated interest on cumulative days at the closing period with the average daily balance over the cycle of a statement.
Even so, the annual percentage rate divided by 365 days gives the daily periodic rate. Interest will be assessed based on the number of days in a statement cycle only if the evaluation of interest is cumulative at the closing date.
The average outstanding balance is also used in other methodologies. For example, a simple average outstanding balance may be used in a statement cycle by dividing the sum of the balance at the beginning and ending period by two, after which interest is evaluated as per the monthly rate.
Credit card issuers disclose their interest assessment methodology in the user agreement. Other credit provider institutions use monthly statements to detail procedures for calculating interest and average balances.
Average Outstanding Balance on Consumer Credit
Credit issuers report outstanding balances to credit reporting agencies every month. The total outstanding balance of a credit card is reported upon receiving the information.
However, while some credit providers may provide updates on their borrowers’ account status at the time a statement is issued, others opt to report outstanding balances on a particular day of every month.
Balances are reported for both revolving and non-revolving credit card users. Lenders also use outstanding balances to help in reporting delinquent payments that are late by sixty or more days. Borrowers’ credit scores are affected by the history and current capacity of outstanding balances.
Loan overdrafts and timeliness of payments are the main factors that determine consumers’ credit scores. In practice, multiple balances and late payments reflect a borrower’s risks of default and lead to limited credit access by credit companies. Usually, borrowers are required to maintain their total outstanding balances below 30%.
Nevertheless, borrowers that exceed the required limit can repair their credit score by making lump-sum payments to reduce the total overdrafts. As the total outstanding balance decreases, the credit score increases, leading to increased accuracy and credit access.
Timeliness is costlier to improve, as it often makes borrowers appear to be at high risk of default. As a result, late payments and delinquencies typically stay on credit reports for a longer time – usually seven years – even if the borrower pays the total outstanding balance in full.
However, if a borrower’s debt repayment or debt accumulation is exhibiting a drastic change over a short period, there will be a time lag in the outstanding balance reported to credit reporting agencies.
Calculating the Average Outstanding Balance
1. Find the average outstanding balance is to identify the time frame. In this example, the time frame is from November to December.
2. Gather all the information about the loan. Obtain the average debt amount at the start and end of a period, i.e., the ending balance of a credit account for two periods. In this case, the assumed ending balance for November is $50,000 and the ending balance for December is $70,000.
3. Find the average of the ending balance from November and the ending outstanding balance for December. For this example, ($50,000 + $70,000) / 2 = $60,000.
4. The average value is divided by the average number of accounts within the loan portfolio. Assuming that the number of accounts within the given period is 5, we get $12,000 ($60,000 / 5).