How Credit Card Interest Rates are Calculated
Unless you pay your balance in full each month, you're going to face finance charges. There are three different methods credit card companies use to calculate the finance charges. By far, the most common method used by credit card companies to calculate finance charges is the average daily balance (ADB) method.
The average daily balance method gives you credit for your payment the same day the card issuer receives it. The ADB is calculated by taking the daily balance on each day of the period minus any payments received, divided by the number of days in the period. Because of the way the ADB is calculated, sending in your payment as early as possible will help you save money in interest charges.
The other two methods used are the adjusted balance and previous balance methods. These methods are rarely used by credit card companies to calculate interest charges.
The adjusted balance method is calculated by subtracting all payments made during the current period from the ending balance due from the last period. Purchases made during the period are not included in the computation.
As the name suggests, the previous balance method is computed by calculating finance charges based on the amount owed at the end of the last billing cycle. Payments, new purchases, etc. are excluded from the computation.
What is the most advantageous method for cardholders?
The adjusted balance method is best for cardholders because it excludes purchases made during the current period and subtracts all payments made from the balance remaining from the last billing cycle. This would result in a lower finance charge.
However, as stated above, most credit card companies, almost 100 percent in fact, use the adjusted daily balance method to calculate finance charges.