The Average Daily Balance, is the average amount that exists in an account over a period of time, the period of time is typically a billing cycle. The average daily balance is calculated by adding the daily balances over a period of time and dividing by the total number of days in that period. This calculation method is used to calculate interest.
The Average Daily Balance and Credit Cards
The average daily balance method is commonly used by credit card companies. This value is used with your APR to determine finance charges. Therefore, it is important to know how this calculation works because it may impact how you use your credit card. Credit card companies calculate your average daily balance by adding your daily balance for each day of the billing cycle then dividing it by the amount of days in the billing cycle. For example, if you spent 30 dollars consistently for a month or for every day in your billing cycle, to calculate your average daily balance you would take the sum of spending 30 dollars for 31 days and divide it by 31, the number of days in the billing cycle.
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To calculate your finance charges your credit card company would then take this value, your average daily balance, and multiply it by the APR and the number of days in the billing cycle. The credit card company then takes this number and divides it by 365, the number of days in a year. Refer to the equation below for more details.
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Now that you, as a consumer, are now aware of how your average daily balance impacts your annual finance charges you can use this information to save money. Spending less and lowering your average daily balance will help you save money overall and lower your finance charges from year to year.
Sources:
http://www.investorwords.com/350/average_daily_balance.html
http://www.thetruthaboutcreditcards.com/two-cycle-average-daily-balance-vs-average-daily-balance/
http://credit.about.com/od/creditcardbasics/qt/avgdailybalance.htm
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