how the average daily balance method works
the average daily balance method can take several different forms including calculations made with or without compounding in either case the formula is average daily balance x daily periodic rate x number of days in the billing cycle interest charge for that monththe computations with and without compounding differ in how they define daily balance in the average daily balance method with compounding the issuer takes the balance at the beginning of each day adds any new charges for that day plus any interest charges on the previous day s balance and then subtracts any payments or credits made that day 1the issuer then adds up all of the daily balances and divides that total by the number of days in the billing cycle the result is the average daily balance following the formula above the average daily balance is then multiplied by the daily periodic rate the annual percentage rate divided by the number of days in the year and finally by number of days in the billing cycle the result is how much the card issuer will charge in interest for that month 1the average daily balance method without compounding works much the same way except that the card issuer doesn t add in the previous day s interest in determining the daily balances because of that the interest does not compound as it does with the other method 1the method with compounding will be more expensive for cardholders and more lucrative for card issuers than the one without other variations on the average daily balance method include average daily balance including new purchases and average daily balance excluding new purchases the former works like the average daily balance method explained above the latter doesn t add in purchases made during that billing period until the next period 2average daily balance method examplehere s a simplified example of the average daily balance method without compounding suppose a credit card has a balance of 1 000 at the beginning of the billing period and an apr of 20 or 0 20 that apr translates into a daily periodic rate of about 0 055 or 0 00055 the cardholder makes a 100 purchase on day 10 of the billing period raising their balance to 1 100 and but no other purchases or payments during the month which happens to have 30 days using this average daily balance method the card issuer would multiply 1 000 by 10 for the first 10 days and 1 100 by 20 for the 20 remaining days that total would be 32 000 10 000 22 000 the issuer would then divide 32 000 by 30 the number of days in the billing period to arrive at an average daily balance of 1066 67 finally to compute the interest charge for the full 30 day billing period the issuer would multiply the average daily balance of 1066 67 by the daily periodic rate of 0 055 and then by 30 in other words 1066 67 x 0 00055 x 30 17 70 one method that s been bannedin years past some credit card companies used a method known as double cycle billing which based its calculations on the customer s average daily balance over the last two billing cycles that sometimes resulted in cardholders paying interest on debt they had already paid off the practice was banned by the credit card accountability responsibility and disclosure act of 2009 better known as the card act 