What does the average daily balance method calculate?

The average daily balance method calculates the total of daily balances maintained over a specific billing period, and then divides that sum by the number of days in that period. This method is commonly used by financial institutions to determine finance charges on credit accounts, such as credit cards or loans.

By using the average daily balance, lenders can more accurately assess the interest owed based on the actual amount owed each day rather than just the balance at the end of the billing cycle. This provides a fairer calculation of interest since it takes into account fluctuations in the balance due to payments or purchases made throughout the billing period.

This method is particularly advantageous for consumers as it often results in lower interest charges compared to methods that may use end-of-period balances or maximum amounts.