The average daily balance is a term and method used by banking companies to calculate interest. The average daily balance method is used to calculate the amount of interest on a credit card payment, taking into account the client’s balance on every day of the billing cycle. The average daily balance itself is calculated by summing the daily balance and dividing the figure by the number of days in the billing cycle.
Explanation:
The balance on a credit card is continuously fluctuating while its owner makes various operations with it. Therefore, a banking company needs a way by which it can be determined how much interest they need to accrue at the end of the billing cycle. One of the options for this calculation is the average daily balance method.
The credit card company calculates the sum from the cardholder’s balances at the end of each day of the billing cycle and divides this figure by the number of days in this cycle. Then, the resulting expression is multiplied by the annual interest rate of the card to determine the calculation of interest. After that, this percentage is added to the interest to the next day’s balance. Thus, the interest is affected by all transactions that occur with the card during the day.
The daily average balance method is just one of many ways in which lenders and borrowers can calculate the interest charged to their clients. The percentages taken using this method are not the highest, and they are lower in comparison to the previous balance method, which calculates interest based on the balance for the last billing cycle. However, the interests on this method are higher than on the adjusted balance method, which is why the latter approach is used much less frequently.