How the 2 cycle average daily balance method affects your finance charges?

How the 2 cycle average daily balance method affects your finance charges?

Do you understanding exactly how the 2 cycle average daily balance method of calculating balance works? Most people don't and just look at the apr when they are trying to choose a low apr credit card. However, the method of calculating your monthly balances is one of the fine prints you have to look out for in the terms and conditions of a credit card.

While many credit cards use the average daily balance method of computing your monthly balance, some credit card use the 2-cycle average daily balance method (which essentially takes the average of the present and last balance that you have incurred). The method of computing balance is one of the factors affecting how much one pays in finance charges a month. This articles examines the implications of credit cards using the 2-cycle average daily balance method of computing balances.

The table below illustrates the finance charges incurred when we use both the average daily balance method and the 2-cycle average daily balance method. We assume an apr of 15% and current monthly balance of $500. Because the 2-cycle method takes the average of the present and previous cycle balances, we also compute the finance charges under 3 scenarios - 1) constant balance ($500), 2) Lower balance the previous month ($200) and 3) a higher balance the previous month ($800).

Illustration
 

Average
Daily Balance
2-cycle Average Daily Balance
APR 15% 15% 15% 15%
Monthly APR
= APR/12
1.25% 1.25% 1.25% 1.25%
Previous
Balance
$500 $500 $200 $800
Current
Balance
$500 $500 $500 $500
Computed
Balance
$500 $500 $350 $$650
Finance
Charges
$6.25 $6.25 $4.375 $8.125


We can conclude a few points from the table above. Firstly, if the balance you carry every month is quite constant, the method of calculating balance (either the standard average daily balance or the 2 cycle average daily balance method) should not matter to you. However, if you are reducing your balance every month, then the 2 cycle average daily balance method will result in higher computed monthly balance and hence higher interest charges (everything else being equal). If your balance is increasing every month, then your computed balance will be lower than your current actual balance. (though no financial adviser will recommend that you carry credit card debts, not to mention increasing them).

If your goal is to reduce your monthly balance (and eventually credit card debt), and if you are thinking of switching to a credit card with a lower apr than your present one, you should avoid credit cards that use the 2 cycle average daily balance method of computing your balance.

Even if you carry a constant balance every month, it is still better to have a credit card that uses the standard average daily balance method of computing balance. This is because over time, you would assume that you would want to gradually reduce your credit card debt. It is also less complicated to calculate and check your balance based on one month's data rather than two. No one carries exactly the same balance from month to month.

Bottom line is : if you carry a balance, it is best to get a low apr credit card that uses the standard average daily balance method of computing balance and avoid credit cards using the 2 cycle average daily balance method. It is also important to note that it is not just smaller issuers who use this method.

For those looking for a low interest credit card, we have compiled a list of low interest credit cards which all use the average daily balance method.