Balance Calculation Methods Part One
26 August 2008How much your credit cards will cost you depends on the costs. It will also depend on the method the card issuer uses to calculate the finance charge. Think about this for a second. A credit card isn’t like a car loan or mortgage where you have a set amount you borrow and then fixed payments you make each month. With a credit card, you’re constantly borrowing different amounts and paying back some or all of the balance. The question is, then, how do they figure out which balance to charge you interest on? That’s where the balance calculation method comes in.
There are several main ways that credit card balances can be calculated, some more expensive than others. Almost all credit card issuers use the “Average Daily Balance, including New Purchases” method, but you’ll see some other methods from time to time. Balance calculation methods are quite complicated, but we’ve listed a brief, and hopefully understandable, description of each. We have listed these in the order of “best” to “worst” for many but never allconsumers.
- Adjusted balance. This balance is figured by deducting payments and credits made during the billing cycle from the outstanding balance at the beginning of the billing cycle. If your beginning balance was $1,000 and you paid $900 of that, you would only be charged interest on the remaining $100.
- Average Daily Balance Excluding New Purchases. This balance is figured by adding the outstanding balance (excluding new purchases and deducting payments and credits) for each day in the billing cycle, and then dividing by the number of days in the cycle. New purchases made during the billing cycle do not raise your balance or increase your finance charge.
- Previous balance. This balance is the outstanding balance at the beginning of the billing cycle. Payments or charges made during the month won’t affect your finance charge this billing cycle.
- Average Daily Balance Including New Purchases. This balance is figured by adding the outstanding balance, including new purchases, and deducting payments and credits, for each day in the billing cycle, and then dividing by the number of days in the billing cycle. Purchases made during the billing cycle raise your balance and increase your finance charge.
- Two-Cycle Average Daily Balance, Excluding New Purchases. This balance is the sum of the average daily balances for two billing cycles. The first balance is for the current billing cycle, and is figured by adding the outstanding balance (excluding new purchases and deducting payments and credits) for each date in the billing cycle, and then dividing by the number of days in the billing cycle. The second balance is for the preceding billing cycle and is figured in the same way as the first balance. Adds interest on the current month’s balance (not including new purchases) together with interest on last month’s balance (not including new purchases).
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