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 annual percentage rate (APR) by 12 calculates the monthly interest rate. The balance generates less interest due than the previous balance method, because payments made toward the credit card balance immediately lowers 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. Adjusted Balance Method

    The adjusted balance method is a method of accounting for financing ...
  2. Previous Balance Method

    The previous balance method is an accounting method where interest ...
  3. Average Balance

    The average balance is the balance on a loan or deposit account ...
  4. Credit Card Balance

    Credit card balance is the amount of charges, or lack thereof, ...
  5. New Balance

    The new balance is the sum of the previous balance, payments, ...
  6. Account Balance

    An account balance is the amount of money in a financial repository, ...
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

    How to decide if a credit card balance transfer is right for you, where to look for one and the steps to take to complete it.
  3. Personal Finance

    Consumer Credit Card Balances Are Down $19 Billion

    Rising balances and credit limits may be fine for now, but with household debt rising faster than GDP, there could be consequences in the next few years.
  4. 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.
  5. Personal Finance

    Credit Card or Cash: Which To Use?

    Credit cards are more convenient to use than cash, but they're not always the best choice. Here is why you should and shouldn't pay with a credit card.
  6. Personal Finance

    Breaking Down Credit Card Fine Print

    Those "perks" offered by credit card companies usually come with strings attached, and these are just a few of them.
  7. Personal Finance

    Credit Card Debt: America’s Biggest Struggle?

    Dealing with credit card debt is a huge struggle for many American families. Here are some tips to get you started.
RELATED FAQS
  1. 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 >>
Trading Center