The average monthly balance is the average of the closing balances for each day in a given month or statement period. The words in the term often get mixed up, but banks use the term “average monthly balance” to define the result of calculations performed at the end of each month. Banks use the standard calculation for finding an average to determine the average monthly balance.
TL;DR (Too Long; Didn't Read)
Banks calculate average monthly balances much like any other average is derived. The formula used involves finding the sum of all daily balances and then dividing by the number of days in the month.
Exploring the Basic Calculation
Banks calculate the average monthly balance by adding together each daily closing account balance throughout the month. The bank divides the sum of the daily account balances by the number of days in the month. For instance, the sum of your daily account balances is $1,345, which is divided by 30 for the number of days in April. The average monthly balance is $48.33.
Understanding Bank Usage
Many banks have minimum average balance requirements you must meet to prevent being assessed fees on bank accounts. Some banks use a combined average monthly balance from all of a customer’s accounts. Banks provide the average monthly balance at the end of the month and after fees have been assessed. Banks usually do not provide daily or running tallies to help you avoid account fees.
Evaluating Creditor Use
If you apply for a loan, your average monthly balance may be one of the factors that creditors use to evaluate the risk of lending to you. Creditors use the average monthly balance to look at your income and spending habits through fluctuations in your daily or monthly average balances. Some creditors look at income stability as reflected in the average monthly balance for deposit accounts. For instance, the U.S. Department of Housing and Urban Development uses a six-month range of the average monthly balance to represent the cash value of a mortgage applicant’s checking account when assessing asset income.
Other Important Considerations
People sometimes use the terms "average monthly balance,” “average daily balance” and “monthly average balance” to refer to the same set of calculations. Some financial institutions use “monthly average balance” to refer to the average of an account’s closing balances at the end of each month throughout a given year. Ask about the term and the calculation used by your bank.
The average daily balance is calculated in the same way as the average monthly balance, but the sum is divided by the number of days in the period rather than the number of days in the month. The average daily balance is used by credit card companies to determine interest, for example. Most banking institutions use months as the guiding time period for calculations rather than any other time period, hence the popularity of the "average monthly balance."
Gail Sessoms, a grant writer and nonprofit consultant, writes about nonprofit, small business and personal finance issues. She volunteers as a court-appointed child advocate, has a background in social services and writes about issues important to families. Sessoms holds a Bachelor of Arts degree in liberal studies.