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The adjusted balance method calculates interest on financial accounts based on the previous closing balance, without taking into account new expenses during the billing cycle. It can result in lower charges and is the basis for interest-free periods on credit cards. Variations include the previous balance and two-cycle balance methods, while the average daily balance method calculates interest based on the average balance at the end of the cycle.
The adjusted balance method is a particular way of calculating interest on a financial account. This covers both interest charged to a borrower and interest paid to a saver. The method involves making a single interest calculation at the end of each period and can produce significantly different results from other methods.
Calculating interest charges or payments using the adjusted balance method is relatively simple. It works based on the interest billing cycle, such as once a month with an account that has a monthly billing cycle. The calculation involves starting with the closing balance of the prior period, subtracting any payments or credits received by the bank during the period, and then using this ending balance to calculate the charge for the month.
The key to the adjusted balance method is that the interest calculation at the end of a billing cycle does not take into account any new expenses during that billing cycle. It is based solely on the previous closing balance and any refunds in the meantime. The practical effect is that if the customer makes a purchase but pays the money before the end of the current billing cycle, they will not be charged any interest on that purchase. This system is the basis of the “interest-free period” on many credit cards.
One point that can be missed with an adjusted balance method is that it often does not take into account any interest charges applied during the cycle. This means that the interest charge calculated at the end of January does not affect the figures used to create the interest charge at the end of February, and so on. This tends to mean that the method produces lower charges.
There are several variations on the adjusted balance method that work on a similar principle but with slightly different details. The previous balance is based solely on the balance at the end of the previous cycle, which means that neither new expenses nor reimbursements during the current cycle affect the new interest charge. The two-cycle balance works by taking the balance from two months ago and taking into account payments since that date; The practical effect is that clients can only get an interest-free period if they always pay the expenses in full before the due date.
The most common method, the average daily balance, works in a completely different way. It means that the bank keeps track of the account balance at the end of each day during the cycle, then calculates an average balance at the end of the cycle. This balance is used to calculate the interest charge for the entire cycle. This can mean higher interest charges, but on the other hand people who pay bills before they are due will benefit.
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