An average daily balance method is one way a credit card issuer calculates the finance charge on your credit card. When we say finance charge, this pertains to how your credit card issuer imposes interest on your account’s balance that you carry behind the grace period. Furthermore, paying a finance charge will increase your credit card debt’s total cost far off than the original purchase price.
Getting To Know The Average Daily Balance Method
The credit card balance continuously changes day by day as the cardholder makes payments or purchases in the account. That is why the credit card issuer needs a way to know how much it costs when the billing cycle ends. Fortunately for them, one way to help them out is using the average daily balance method.
The average daily balance is used only for cardholders who could not fully pay their statement balance on time at the end of the month. Most of the time, borrowers are given a grace period for a chance to pay the unpaid balance. Yet, on the following day, after the grace period expires, the credit card issuer most likely will start to charge interest based on the average daily balance.
How Does The Average Daily Balance Works
Your average daily balance is the total of your balance per day in the billing cycle divided by the number of days in the billing cycle. Moreover, the average daily balance method for calculating finance charge takes your total balance during the billing cycle then multiplies it by the annual percentage rate (APR) for the said balance.
The calculation will look like this:
Average daily balance x total number of days in the billing cycle x annual percentage rate (APR) / 365 (number of days in a year
Example Using The Average Daily Balance Method
Suppose your credit card has an APR of 12%, and the preceding balance is $400. On day 13 of your billing cycle, the credit card company receives and credits your payment of $250. On day 19, you made a purchase worth $150. Your daily balance for each day during the billing cycle would look like this:
Day 1-12: $400
Day 13-18: $150 ($250 credit)
Day 19-30: $300 ($150 purchase)
To determine your average daily balance, you need to sum up your daily balances in the billing cycle and divide it by the total number of days in the billing cycle, which in this case is 25.
(Day 1 balance + day 2 balance + day 3 balance…) / total number of days in the billing cycle
([$400 x 12 days] + [$150 x 6 days] + [$300 x 7 days]) =7,800
$7,800/ 25 days = $312
Your average daily balance is $312. You can then proceed to get the finance charge with this solution: Average daily balance x total number of days in the billing cycle x annual percentage rate (APR) / 365 (number of days in a year).
$312 x .12 x 25 / 365 =$2.56
Based on the calculation above, your finance charge is $2.56. If you continue making no additional charges and minimum payments on this account, you might pay $30.72 in finance charge over one year.
Other Types of Balance Method To Compute Finance Charges
The average daily method is known to be less expensive than the other methods out there. To know more about other methods used in calculating finance charges, here are some of the most common:
- Adjusted Balance Method
With the adjusted balance method, the interest charges are based on the sum owed at the end of the current billing cycle after payments and credits have been posted.
- Previous Balance Method
With the previous balance method, the interest charges depend upon the sum you owed at the end of the beginning of the billing cycle.
To know what type of balance method your credit card issuer uses to calculate finance charge, it would be best to communicate with your credit card issuer or simply check your credit card billing statement.