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. Previous Balance Method

    A credit card accounting method where interest charges are based ...
  2. Credit Card Balance

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

    The amount of money a consumer pays for borrowing money on a ...
  4. Double-Cycle Billing

    A method used by creditors, usually credit card companies, to ...
  5. New Balance

    The new balance is the sum of your previous balance, payments, ...
  6. Past Due Balance Method

    A system for calculating interest charges based on any outstanding ...
Related Articles
  1. Personal Finance

    Everything You Need To Know About Credit Card Rates

    Understanding credit card rates will help you choose the right credit card, and avoid any unpleasant surprises.
  2. Personal Finance

    How Credit Card Balance Transfers Work

    The pros and cons of credit card balance transfers.
  3. 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.
  4. Personal Finance

    Should You Use Credit Cards To Fund Your Business?

    We give you 4 reasons to consider using a credit card instead of a business loan to fund your business, and how to be smart about it.
  5. 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?
  6. 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.
  7. 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.
  8. 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.
  9. Personal Finance

    Understanding Credit Cards

    Credit cards are a type of unsecured personal loan between the credit card issuer and the credit card holder.
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. Do balance transfers hurt your credit?

    The extent of the hit to your credit score depends on credit utilization. Read Answer >>
  3. What's the difference between a balance transfer and a cash advance?

    Learn how balance transfers and cash advances differ, how these transactions can both benefit and hurt your finances, and ... Read Answer >>
  4. 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 >>
  5. How is the minimum payment on a credit card calculated?

    Even when minimum payments are low, consumers should still aim to pay off credit card balances every month. Read Answer >>
Hot Definitions
  1. Treynor Ratio

    A ratio developed by Jack Treynor that measures returns earned in excess of that which could have been earned on a riskless ...
  2. Buyback

    The repurchase of outstanding shares (repurchase) by a company in order to reduce the number of shares on the market. Companies ...
  3. Tax Refund

    A tax refund is a refund on taxes paid to an individual or household when the actual tax liability is less than the amount ...
  4. Gross Domestic Product - GDP

    The monetary value of all the finished goods and services produced within a country's borders in a specific time period, ...
  5. Inflation

    The rate at which the general level of prices for goods and services is rising and, consequently, the purchasing power of ...
  6. Merchandising

    Merchandising is any act of promoting goods or services for retail sale, including marketing strategies, display design and ...
Trading Center