Average Daily Balance
There’s a good chance you’ve never heard the term “Average Daily Balance” (ABD), but it affects over 75% of American adults. And that’s because over 75% of American adults have at least one credit card.
In essence, ABD is a formula that determines how much interest you’ll pay at the end of your credit card billing cycle. If you think the interest charge is calculated by multiplying your APR by the balance on your card at the end of the month, you are wrong.
It’s actually calculated by multiplying your APR by—you guessed it—your average daily
balance. That means you could be paying much more interest than you need to! Let’s use an example to illustrate why: imagine you receive two paychecks each month—one in the middle and one at the end. Since you don’t know about ADB, you wait until the end of the month to make your credit card payment. That means the average balance on your card throughout the month is as high as possible…leading to higher interest charges.
What if you instead split your credit card payment into two – one in the middle of the month and one at the end? If you started the month with a balance of $4,000 and made a payment mid-month of $3,000, your average daily balance for the month would be $2,500—which is $1,500 lower than what it would have been if you waited until the end of the month to pay. Assuming your APR on the card is 20%, you would save yourself about $3,000 worth of unnecessary interest charges per year!
Believe it or not, you can be penalized for using all the credit that has been offered to you. That’s because one of the main variables in determining your credit score is how much of your available credit you’re using. The term “credit utilization” refers to the ratio of your total debt to your remaining available credit. For example, if you own a credit card with a credit limit of $20,000 and then you put enough purchases on it to reach the limit, your credit utilization would be 100%. As you can probably guess, that’s not good for your credit score. Further, if you also had an auto loan for $20,000 that was half paid off, then your total credit utilization would be 75%. Experts usually recommend a credit utilization of no more than 30%, but it depends on your individual situation.
Understanding this concept can help you save money throughout your life. Many people close a credit card once it has a zero balance, but if you’re informed about credit utilization you will often realize it makes sense to leave the card open (as long as it won’t tempt you to get in debt). As long as it remains open, the available credit on the card will help your credit utilization—and boost your credit score.