Average Daily Balance Finance Charge Calculation

How Creditors Use the Average Daily Balance Method

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The average daily balance method is one of five different ways a credit card issuer can calculate finance charges on your credit card. Your billing statement will describe the method your credit card issuer uses to calculate your finance charge.

The average daily balance method uses the average of your balance during the billing cycle multiplied by the APR for that balance. Your average daily balance is the sum of your balance on each day of the billing divided by the number of days in the billing cycle.

Here is the calculation for the average daily balance method: average daily balance * APR * days in billing cycle / 365

Calculating the Average Daily Balance

If you want to calculate your own finance charge, you have to know your credit card balance for each day of the billing cycle. While your credit card statement won't list each day's credit card balance, you can use your statement (or your online transaction log) to figure out the balance. Start with the balance at the beginning of the billing cycle. Then, add or subtract from the balance each day you have new transaction.

Let’s say your APR is 12% and your billing cycle is 25 days long.

You started the billing cycle with a balance of $100. On Day 4, you made a $100 purchase. On Day 20, a $25 payment was credited to your account. Your daily balance for each day during the billing cycle was:

Day 1 – 3: $100
Day 4 – 20: $200 ($100 purchase)
Day 20 – 25: $175 ($25 credit)

To calculate your average daily balance you must total your balance from each day in the billing cycle (even the day's that your balance didn't change) and divide the total by the number of days in the cycle.

(Day 1 Balance + Day 2 Balance + Day 3 Balance…) / number of days in billing cycle

$4575 / 25 = $183

Calculating the Average Daily Balance Finance Charge

Calculating the average daily balance is the hardest part. From there, you simply multiply by your credit card's APR and number of days in the billing cycle to calculate the finance charge.

Based on the details listed above, your finance charge using the average daily balance method would be:

$183 * .12 * 25 / 365 = $1.50

If you continued making minimum payments and no additional charges on this account, you'd pay $18.00 in finance charges over the course of a year.

Why Does the Billing Cycle Matter?

Credit card companies state your interest rate in terms of an annual percentage rate, or APR, to make it easier to compare various credit cards and loans. However, you are not charged interest on an annual basis. You're charged interest periodically based on your billing cycle. Including the billing cycle in the finance charge calculation ensures you are charged interest only for that specific period of time.

Balances With Different APRs

If you have balances with different APRs on your credit card, the finance charge for these balances is calculated separately.

For example, you'll have a finance charge for purchases, one for balance transfers, and one for cash advances if you had all these balances on your credit card. So, if you're calculating your own finance charge, you will have to calculate the average daily balance separately for each. 

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