What is 'Average Daily Balance Method'

The average daily balance is a common accounting method where credit card interest charges are calculated using the total amount due on a card at the end of each day. The average daily balance totals each day's balance for the billing cycle and divides by the total number of days in the billing cycle. Then, the balance is multiplied by the monthly interest rate to assess the customer's finance charge.

BREAKING DOWN 'Average Daily Balance Method'

Dividing the cardholder's APR by 12 calculates the monthly interest rate. The balance generates less interest due than the previous balance method, because payments toward the credit card's balance immediately lower the total balance. This balance is typically the most profitable for credit card companies.

Effect on Balances

The average daily balance calculates interest by considering the balance invested or owed at the end of each day of the billing period rather than the balance invested or owed at the end of the week, month or year.

Compound interest affects how borrowers and lenders use the average daily balance method. Borrowers and lenders use the balance to calculate interest if the interest compounds monthly. An investor must understand how an institution's choice of accounting methods used to calculate interest affect the amount of interest deposited into investor’s account.

How It Works

Some credit card companies previously used the double-cycle billing method that assessed a customer’s average daily balance over the last two billing cycles, which was a justification for charging more interest. The credit card company totaled a customer’s balance each day during the billing cycle, added these balances together and divided by the number of days in the billing period. A billing period is usually a 30-day period.

The average daily balance credits a customer’s account from the day the credit card company receives a payment. To assess the balance due, the credit card company sums the beginning balance for each day in the billing period and subtracts any payments as they arrive and any credits made to the customer’s account that day.

Cash advances are usually included in the average daily balance. The total balance due may fluctuate daily because of payments and purchases. For example, a credit card has a monthly interest rate of 1.5 percent, and the previous balance is $500. On the 15th day of a billing cycle, the credit card company receives and credits a customer’s payment of $300. On the 18th day, the customer makes a $100 purchase. The average daily balance is (14 x 500) + (16 x 200) = / 30 = (7,000 + 3,200) / 30 = $340. The bigger the payment a customer pays and the earlier in the billing cycle the customer makes a payment, the lower the finance charges assessed.

Options

There are several interest calculation methods in use; therefore, borrowers should compare credit card offers from lenders, and investors should compare investment offers by reading the disclosure that accompanies those offers to ensure that they select a product that meets their needs.

RELATED TERMS
  1. Credit Card Balance

    The amount of charges, or lack thereof, owed to the credit card ...
  2. Total Finance Charge

    The amount of money a consumer pays for borrowing money on a ...
  3. Past Due Balance Method

    A system for calculating interest charges based on any outstanding ...
  4. Average Balance

    The balance on a loan or depositary account. A simple average ...
  5. Minimum Payment

    The smallest amount of a credit card bill that a credit card ...
  6. Zero Balance Card

    A credit card on which a consumer does not owe any money because ...
Related Articles
  1. Personal Finance

    Why Making Minimum Payments Gets You Nowhere

    Getting out of debt can be difficult, but paying off a minimum balance each month only makes things worse.
  2. Personal Finance

    The Credit Card Balance Transfer Trap

    Before you transfer a balance to a credit card with a lower interest rate, know how it affects new purchases and other fine-print traps that can cost you.
  3. Personal Finance

    0% Balance Transfers: Can You Beat the Odds?

    Before you accept that 0% balance transfer offer, understand why you got it and who will probably profit most. Only accept if you can beat the odds.
  4. Personal Finance

    The Fed's Interest Rate Rise & Your Credit Cards

    The U.S. Federal Reserve recently raised the lending rate from 0% to 0.25% – the first time since 2006. How does that affect your credit card payments?
  5. Personal Finance

    How To Read Loan And Credit Card Agreements

    The devil is always in the details! Find out what you're signing yourself up for.
  6. Personal Finance

    Don't Get Burned by High Credit Card Rates

    The average card charges 11.8%, and some rates top 20%. Experts warn that credit card interest may remain steep.
  7. Personal Finance

    The Pros And Cons Of Balance Transfers

    Do the math before you assume that transferring your credit card balance to a lower rate card will save money. It could – or it could cost you.
RELATED FAQS
  1. How is interest charged on most lines of credit?

    Learn how most financial institutions calculate interest on lines of credit by using the average daily balance method and ... Read Answer >>
  2. When is a balance transfer a good idea for paying off debt?

    Learn the best situation in which to do a balance transfer, enabling you to pay off your credit card debt more quickly while ... Read Answer >>
  3. Because I missed a few credit card payments, the issuer raised my interest rate from ...

    You should first check that your credit card company is operating within your rights as a card holder. The U.S. Congress ... Read Answer >>
Hot Definitions
  1. Treasury Bill - T-Bill

    A short-term debt obligation backed by the U.S. government with a maturity of less than one year. T-bills are sold in denominations ...
  2. Index

    A statistical measure of change in an economy or a securities market. In the case of financial markets, an index is a hypothetical ...
  3. Return on Market Value of Equity - ROME

    Return on market value of equity (ROME) is a comparative measure typically used by analysts to identify companies that generate ...
  4. Majority Shareholder

    A person or entity that owns more than 50% of a company's outstanding shares. The majority shareholder is often the founder ...
  5. Competitive Advantage

    An advantage that a firm has over its competitors, allowing it to generate greater sales or margins and/or retain more customers ...
  6. Mutual Fund

    An investment vehicle that is made up of a pool of funds collected from many investors for the purpose of investing in securities ...
Trading Center