Credit cards can be pretty exciting, allowing you to scale purchases strategically. To boost said strategy and avoid debt traps, you will need to understand how daily balances are calculated and how to use this knowledge to plan spending wisely.
Ideally, as long as you pay off your balance in full within the due period, you won’t be charged any interest. Still, 40.7% of Americans have a revolving balance and end up paying interest. With a strong revolving balance strategy, you will avoid these interest charges.
How revolving credit interest is calculated
The interest you pay on your credit card is determined by the annual percentage rate (APR) of your account and the balance you carry beyond the grace period.
However, the balance your bank or credit issuer uses to calculate the interest isn’t necessarily the balance displayed on your statement. Instead, they could be using your average daily balance for that billing period.
Understanding credit card interest charges can help you estimate the interest you’ll owe if you don’t pay your full balance by the due date. . It also makes it easier to compare different credit cards and choose the best one for you.
But first, you need to know how to calculate your average daily balance. So here’s a complete guide on how to calculate the average daily balance of your credit account:
What is an average daily balance?
Your credit card balance changes on a day-to-day basis as you make payments or purchases in the account. The average daily balance is a standard accounting method used to calculate interest charges on your credit account and is determined using the balance owed at the end of each day of your billing cycle rather than the balance at the end of the cycle.
Banks and credit card companies calculate the average daily balance by taking the amount owed on each day, adding them together, and then dividing the total by the number of days in the billing cycle. While they typically use computers to calculate this, it’s possible to figure it out yourself too. Here’s an example:
How do you calculate the average daily balance?
Let’s say you have a 30-day billing period and start the period with a $200 balance. On day 10, you make a $100 purchase. On day 15, you make a $450 purchase. On day 25, you make a $550 payment.
Your daily balances are:
- $200 for the first 10 days,
- $300 for the next 5 days,
- $750 for the next 10 days,
- $200 for the final 5 days.
Then, add up all your daily balances:
- 10 x $200 = $2,000
- 5 x $300 = $1,500
- 10 x $750 = $7,500
- 5 x $200 = $1,000
The sum of your daily balances = 2,000 1,500 + 7,500 + 1,000 = $12,000
And finally, divide your sum by the 30 days in the billion period.
Average daily balance = $12,000 / 30 =$400
How does average daily balance work?
There are three components for calculating interest charges using the average daily balance method:
- The card’s billing cycle
- The outstanding balance due on your card at the end of each day of the billing cycle
- The APR charge applied to the average daily balance on your card
Once your average daily balance is calculated (as shown above), the credit company multiplies this amount by the card’s APR to determine your interest charges.
The formula for calculating your interest charges is:
Average Daily Balance x APR Days in the Billing Cycle365
The average daily balance is used for people who haven’t paid off their statement balance in full on time at the end of the month and hence have an existing balance on the first day of the new billing cycle.
The sooner you make payments, the lesser your average daily balance will be for the next cycle. If you pay off your entire balance on time, your credit card company won’t charge you any interest.
Limitations of the average daily balance
Your average daily balance doesn’t tell you the final interest charge on your account. Additionally, the more often you use your credit card, the more challenging it can be to keep track of your daily borrowing and payments, making it harder to estimate your average daily balance.
While your credit card statement might not list each day’s balance, you can check your online banking transactions to keep track of this. You’d have to start with the balance on the first day of the billing cycle and then add or subtract every new transaction you make until the last day.
Other ways to calculate interest owed on credit card balances
The most common methods companies use to calculate your interest charges are:
- Average daily balance method: Considers the balance on each day of the billing period, as opposed to the balance at the end of the billing period, to calculate interest charges.
- Previous balance method: Considers the amount owed at the beginning of the billing period to determine interest charges. So it uses the previous month’s balance, and no transactions that take place during the current cycle will affect the calculation.
- Adjusted balance method: Considers the balance owed at the end of the current billing period after deducting your credits and payments. The adjusted balance method is favorable for credit card owners where the interest charges are calculated after payments and credits have been posted. New purchases and charges aren’t considered while using this method, so you won’t be charged any interest as long as you pay off the balance on time. The adjusted balance method usually results in the lowest interest charges; however, not many credit card companies use this method.
The previous balance method charges interest based on the balance owed before payments and credits are deducted. Hence, it results in the highest interest charge. Most credit card companies use either the average daily balance method or the previous balance method.
Check with your credit card issuer to see which interest balance method they use. You can often find information about this on your card agreement or billing statement.
Why low APR matters
Consider a card with a low APR rate (such as Vital) if you carry a balance from month to month. You can avoid interest all together by paying your full balance at or before the balance due date. Avoid Credit Card Interest Charges
So the total amount you owe at the end of each day can be used to calculate your interest charges. Your credit card issuer will sum up any amounts owed and subtract any payments received every day of your billing period to determine your average daily balance.
Understanding your credit card’s interest, fee rates, and terms make it easier to choose credit cards.
We invite you to check out Vital now. We are the credit card that pays you to share and spend responsibly.
While we won't promise "no fees," we do state our fees and why we charge them up front, to help you understand your best balance pay options. Through transparency and community, we are building a network of credit health transformation.
Sources
“Credit Card Market Monitor,” American Bankers Association
Vital Card blog posts are intended for informational purposes only and should not be considered financial or any other type of advice.