Table of Contents
- What Is the Average Daily Balance Method?
- Key Takeaways
- Types of Finance Charge Calculation Methods
- Important Note
- How the Average Daily Balance Method Works
- The Average Daily Balance Method With Compounding
- The Average Daily Balance Method Without Compounding
- Other Variations
- Average Daily Balance Method Example
- One Method That's Been Banned
- What Is a Grace Period?
- How Can You Find Out if Your Credit Card Uses the Average Daily Balance Method?
- Is Credit Card Interest Tax Deductible?
- The Bottom Line
What Is the Average Daily Balance Method?
I'm here to explain the average daily balance method, which is how many credit card issuers figure out the interest you owe. It looks at your card's balance every single day during the billing period and uses that to calculate charges.
Key Takeaways
You need to know that this method is standard for credit card interest. It relies on your daily balances over the billing period. Then, it multiplies the average by the daily periodic rate and the days in the period. Remember, the APR divides into the daily rate by 365 or 366 in leap years.
Types of Finance Charge Calculation Methods
Under the Truth in Lending Act, issuers must tell you how they calculate finance charges, including APR and fees, in their terms. This lets you compare cards directly. Issuers can pick from methods like the average daily balance, which is most common and uses end-of-day balances from the last cycle; the previous balance method, based on what you owed at the start of the cycle; or the adjusted balance method, which subtracts payments and credits from the prior period's end balance, ignoring new purchases until next month.
Important Note
If you pay your full credit card balance every month, you avoid interest charges completely.
How the Average Daily Balance Method Works
This method comes in forms with or without compounding, but the core formula is the same: average daily balance times daily periodic rate times days in the cycle equals your monthly interest. The difference is in how daily balances are figured.
The Average Daily Balance Method With Compounding
With compounding, the issuer starts with your balance each day, adds new charges and interest from the day before, then subtracts payments or credits. They sum all those daily totals and divide by the cycle's days to get the average. Multiply that by the daily rate—APR divided by days in the year—and by the cycle days to find your interest.
The Average Daily Balance Method Without Compounding
Without compounding, it's similar, but they skip adding the previous day's interest to daily balances. This means interest doesn't build on itself, making it cheaper for you and less profitable for the issuer compared to the compounding version.
Other Variations
You might see variations like including or excluding new purchases. The including version adds them right away, just like the main method. The excluding one waits until the next period to factor them in.
Average Daily Balance Method Example
Let me walk you through a simple example without compounding. Say your card starts with a $1,000 balance and a 20% APR, which is a 0.055% daily rate. On day 10 of a 30-day period, you buy $100, bumping it to $1,100, with no other activity. The issuer calculates $1,000 for 10 days and $1,100 for 20 days, totaling $32,000. Divide by 30 for an average of $1,066.67. Then, $1,066.67 times 0.00055 times 30 gives $17.70 in interest.
One Method That's Been Banned
In the past, double-cycle billing used averages over two cycles, sometimes charging interest on paid-off debt. The CARD Act of 2009 banned it.
What Is a Grace Period?
A grace period runs from the billing period's end to your payment due date. Pay off your balance before it ends, and you skip interest. It's usually at least 21 days, but might not cover things like cash advances.
How Can You Find Out if Your Credit Card Uses the Average Daily Balance Method?
Check your card agreement for the calculation method. If you lost it, request one from the issuer—law requires they provide it.
Is Credit Card Interest Tax Deductible?
No, you can't deduct credit card interest for personal expenses on your taxes anymore. That changed with 1986 reforms.
The Bottom Line
This method is the go-to for credit card finance charges. Understand it to potentially save money, but the best way is to pay your balance in full each month and avoid interest.
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