# Average Daily Balance Method: Definition and Calculation Example

![Young woman looks over her credit card statement](https://www.investopedia.com/thmb/0O1KZpOI_QYHJ1_X4rs3C5jfh0Q=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/StatementClosingDatevs.PaymentDueDateMay182021-12bee5079f064edabb24b1e4113d9759.jpg)

*— Ezra Bailey / Getty Images*

> **Definition**
>
> The average daily balance method calculates the amount of interest to be charged to a borrower on an outstanding loan, taking into account the balance of the account on each day of the billing period.

## What Is the Average Daily Balance Method?

The average daily balance method is a common way that credit card issuers calculate the interest charges cardholders have to pay. It is based on the card's outstanding balances on each day of the billing period.

### Key Takeaways

*   The average daily balance method is commonly used to calculate credit card interest charges.
*   It is based on the card's outstanding balances on each day of the billing period.
*   The average daily balance is multiplied by the card's daily periodic rate and the number of days in the billing period.
*   The card's annual percentage rate (APR) is the daily periodic rate divided by 365 (or 366 in a leap year).

## Types of Finance Charge Calculation Methods

The federal [Truth-In-Lending Act](https://www.investopedia.com/terms/t/tila.asp) (TILA) requires credit card issuers to disclose their method of calculating finance charges, as well as the [annual percentage rate (APR)](https://www.investopedia.com/terms/a/apr.asp), fees, and other terms on the card, in their [terms and conditions](https://www.investopedia.com/terms/t/terms-and-conditions-credit-card.asp) statement. Providing these details makes it easier for consumers to compare different credit cards.

To calculate their finance charges, card issuers can use any of several different methods. Among them are:

*   **Average daily balance method:** This is currently the most common method. It uses the balance at the end of each day of the just-ended billing cycle to calculate finance charges.
*   **[Previous balance method](https://www.investopedia.com/terms/p/previousbalancemethod.asp):** Here, interest charges are based on the amount owed at the beginning, rather than the end, of the latest billing cycle.
*   **[Adjusted balance method](https://www.investopedia.com/terms/a/adjustedbalancemethod.asp):** This least common method bases finance charges on the amount owed at the end of the previous billing period minus any credits and payments made during the current period. New purchases won't be reflected until the next month's billing statement.

> **Important**
>
> If you pay your credit card balance in full each month, you won't have to pay interest.

## How the Average Daily Balance Method Works

The average daily balance method can take several forms, including calculations made with or without compounding.

In either case, the formula is:

_Average daily balance x daily periodic rate x number of days in the billing cycle = monthly interest charged_

The computations with and without compounding differ in how they define "daily balance."

### The Average Daily Balance Method With Compounding

In the average daily balance method with compounding, the issuer takes the balance at the beginning of each day, adds any new charges for that day plus any interest charges on the previous day's balance, and subtracts any payments or credits made that day.

The issuer then adds up all the daily balances and divides that total by the number of days in the billing cycle. The result is the average daily balance.

Using the formula above, the average daily balance is multiplied by the daily periodic rate (the annual percentage rate divided by the number of days in the year) and finally by the number of days in the billing cycle. The result is how much the card issuer will charge in interest for that month.

### The Average Daily Balance Method Without Compounding

The method without compounding works much the same way, except that the card issuer doesn't add the previous day's interest in determining the daily balances. Because of that, the interest does not compound as it does with the other method.

The method with compounding will be more expensive for cardholders and more lucrative for card issuers than the one without.

### Other Variations

There are other variations on the average daily balance method, as well. These include average daily balance, _which includes_ new purchases, and average daily balance, _which excludes_ new purchases. The former works like the average daily balance method explained above. The latter doesn't add purchases made during that billing period until the next period.

## Average Daily Balance Method Example

Here's a simplified example of the average daily balance method without compounding.

Suppose a credit card has a balance of $1,000 at the beginning of the billing period and an APR of 20% (or 0.20). That APR translates into a daily periodic rate of about 0.055% (or 0.00055).

The cardholder makes a $100 purchase on day 10 of the billing period, raising their balance to $1,100, but no other purchases or payments during the month (which happens to have 30 days).

Using this average daily balance method, the card issuer would multiply $1,000 by 10 for the first 10 days and $1,100 by 20 for the 20 remaining days. That total would be $32,000 ($10,000 + $22,000).

The issuer would then divide $32,000 by 30 (the number of days in the billing period) to arrive at an average daily balance of $1,066.67.

Finally, to compute the interest charge for the full 30-day billing period, the issuer would multiply the average daily balance of $1,066.67 by the daily periodic rate of 0.055% and then by 30.

In other words, $1,066.67 x 0.00055 x 30 = $17.70.

## One Method That's Been Banned

In years past, some credit card companies used a method known as [double-cycle billing](https://www.investopedia.com/terms/d/double-cycle-billing.asp), which based its calculations on the customer's average daily balance over the last two billing cycles. That sometimes resulted in cardholders paying interest on debt they had already paid off. The practice was banned by the Credit Card Accountability Responsibility and Disclosure Act of 2009, better known as the [CARD Act](https://www.investopedia.com/terms/c/credit-card-accountability-responsibility-and-disclosure-act-of-2009.asp).

## What Is a Grace Period?

A [grace period](https://www.investopedia.com/terms/g/grace-period-credit.asp) is a period of time between the end of the billing period and when your credit card payment is due. You can avoid paying interest if you pay off your balance before the grace period ends. Grace periods tend to last for at least 21 days but can be longer, and they may not apply to all charges, such as [cash advances](https://www.investopedia.com/ask/answers/111414/how-does-interest-work-cash-advance-my-credit-card.asp).

## How Can You Find Out if Your Credit Card Uses the Average Daily Balance Method?

The credit card agreement you received when you signed up for the card will tell you what method the issuer uses to determine your finance charges, along with other information. If you no longer have a copy, you can request one from the issuer. According to the Consumer Financial Protection Bureau, "By law, the issuer must make your agreement available to you upon request."

## Is Credit Card Interest Tax Deductible?

Not anymore. According to the Internal Revenue Service, "Credit card and installment interest incurred for personal expenses," cannot be deducted on your tax return. Before tax reforms in 1986, however, it was deductible.

## The Bottom Line

The average daily balance method is the most commonly used way of computing finance charges on credit cards today. Knowing how it works may save you some money, but you'll save even more if you can pay your balance in full each month and not incur interest in the first place.

> **Article Sources**
>
> 1.  Consumer Financial Protection Bureau. "[Credit Card Contract Definitions](https://www.consumerfinance.gov/data-research/credit-card-data/know-you-owe-credit-cards/credit-card-contract-definitions/)."
>     
> 2.  Experian. "[How To Calculate Average Daily Balance](https://www.experian.com/blogs/ask-experian/how-to-calculate-average-daily-balance/)."
>     
> 3.  Financial Security for All. "[How Do Credit Card Companies Determine the Balance on Which Interest Is Charged?](https://personal-finance.extension.org/how-do-credit-card-companies-determine-the-balance-on-which-interest-is-charged/)"
>     
> 4.  Capitol One. "[Grace Period: What It Is and How It Works for Credit Cards](https://www.capitalone.com/learn-grow/money-management/credit-card-grace-period/)."
>     
> 5.  Consumer Financial Protection Bureau. "[What Is a Grace Period for a Credit Card?](https://www.consumerfinance.gov/ask-cfpb/what-is-a-grace-period-for-a-credit-card-en-47/)"
>     
> 6.  Consumer Financial Protection Bureau. "[Credit Card Agreement Database](https://www.consumerfinance.gov/credit-cards/agreements/)."
>     
> 7.  Internal Revenue Service. "[Topic No. 505, Interest Expense](https://www.irs.gov/taxtopics/tc505)."
>     
> 8.  Urban Institute. "[Reforming the Mortgage Interest Deduction](https://webarchive.urban.org/uploadedpdf/412099-mortgage-deduction-reform.pdf)," Page 1.