Definition:
The average daily balance method is a method used to calculate interest on revolving credit accounts, such as credit cards. It involves calculating the average daily balance of the account over the billing cycle and then applying the interest rate to that average.
Key points about the average daily balance method:
- Daily balance: The balance of the account is calculated at the end of each day during the billing cycle.
- Average daily balance: The average daily balance is calculated by adding up the daily balances and dividing by the number of days in the billing cycle.
- Interest calculation: Interest is calculated by multiplying the average daily balance by the daily periodic rate.
- Grace period: Many credit cards offer a grace period during which interest is not charged on purchases.
Why is the average daily balance method used?
- Accuracy: The average daily balance method provides a more accurate calculation of interest than the previous balance method.
- Fairness: It’s considered a fairer method for calculating interest, as it takes into account the balance of the account throughout the billing cycle.
In essence, the average daily balance method is a widely used method for calculating interest on revolving credit accounts, and it provides a more accurate and fair calculation compared to the previous balance method.
