Copyright © 2008, The McGraw-Hill Companies, Inc.
10.1 Credit Cards 421Suppose, for example, that at the beginning of April I owe a $500 balance on my credit
card. On April 5 I charge $300, on April 14 I make a $200 payment, and on April 30
I charge $1,600. A history of my balance from day to day in April would look something
like this:Effective Date Activity BalanceApril 1 Start of Month $500
April 5 Charged $300 $800
April 14 Paid $200 $600
April 30 Charged $1,600 $2,200If we are going to calculate my interest monthly, then what should we use as the principal?
At the end of the month the balance was $2,200. But it hardly seems fair to charge a full
month’s worth of interest on that amount, since except for the one day at the end of the
month my balance was much lower. At the start of the month the balance was $500, but
using that as the principal would be ignoring the higher balances carried through the rest
of the month.
There is more than one way that interest can be calculated for a credit card, but the most
common is known as the average daily balance (ADB) method. With the ADB method,
interest is computed and added to the account monthly, and the question of principal is
answered by charging interest on the average of the daily balances through the month. This
seems like a fair way to tackle the problem of the fluctuating balances.
But how do we calculate the average? If we were to take a straight average of the four
balances shown in the table, we would get:Average $500 _____________________________ $800 $600 $2,200
4$1025
This doesn’t seem to be a fair representation of the “average” balance on the card for the
month, though. For 29 of the 30 days in the month, the balance was $800 or less, and so an
“average” of $1,025 isn’t consistent with what really happened on the card during the month.
The problem with a straight average like this is that it doesn’t take into account the
amount of time that the card stayed at each of these balances. The $2,200 balance was
only in effect for a single day, and so it should not carry the same weight in our average as
the lower balances that were in effect for longer. The time that each balance was in effect
should be factored into our average in some way.
Let’s try looking at the average in a different way. Imagine that we take a calendar of the
month of April, and write the account balance on each day. The result would be something
like this:APRIL
1
$500
2
$500
3
$500
4
$500
5
$800
6
$800
7
$800
8
$800
9
$800
10
$800
11
$800
12
$800
13
$800
14
$600
15
$600
16
$600
17
$600
18
$600
19
$600
20
$600
21
$600
22
$600
23
$600
24
$600
25
$600
26
$600
27
$600
28
$600
29
$600
30
$2,200
A more reasonable and fairer way to find an average daily balance would be to average all
of the balances written on this calendar. This would take into account the length of time