Legal Definitions - average daily balance

The term average daily balance refers to a method used, primarily in financial contexts like credit cards or lines of credit, to calculate interest charges or interest earned over a specific billing period. It is determined by summing the outstanding principal balance for each day in the billing cycle and then dividing that total by the number of days in the cycle. This calculation provides a representative balance that accounts for fluctuations due to payments, purchases, or withdrawals throughout the period, ensuring that interest is applied fairly based on the actual amount owed or held each day.

• Credit Card Interest: Imagine Sarah has a credit card with a billing cycle from May 1st to May 31st. On May 1st, her balance is $500. On May 10th, she makes a $200 purchase, increasing her balance to $700. On May 20th, she makes a $300 payment, reducing her balance to $400. To calculate the interest for May, the credit card company will sum her daily balance for each day in May (e.g., $500 for 9 days, $700 for 10 days, $400 for 12 days) and then divide by 31 (the number of days in May). This resulting average daily balance is then used to compute the interest she owes for that month, reflecting the varying amounts she owed throughout the cycle.

• Business Line of Credit: A small business, "Innovate Tech," has a revolving line of credit with its bank. During a 30-day billing period, Innovate Tech might draw $10,000 on day 1, repay $5,000 on day 15, and then draw another $3,000 on day 25. The bank needs to charge interest on the funds borrowed. Instead of using only the highest or lowest balance, the bank calculates the average daily balance. It sums the outstanding principal balance for each of the 30 days (e.g., $10,000 for 14 days, $5,000 for 10 days, $8,000 for 6 days) and divides by 30. This average balance accurately represents the total amount of credit utilized over the period, ensuring the interest charged reflects the actual borrowing activity.