By Mike Azzara | American Express Credit Intel Freelance Contributor
5 Min Read | November 30, 2020 in Cards
You might think, “What is a credit card balance?” is too simple a question to even ask. But things are not always as simple as they seem – consider the millions of lines of software code needed to make your mobile phone simple to use. What makes the definition of credit card balance complex is that there are at least five different things that people could call “credit card balances” – and each one plays a different role in the everyday processes necessary to make your credit card work.
Here are the credit card balances I’ll define in this article:
Along the way, I’ll explain why the idea that you should “carry” a balance is a potentially costly myth.
The statement balance is likely the one that first comes to mind when you think about your credit card balance. It’s the total you owed on the last day of your monthly billing cycle – which usually does not coincide with the end of a calendar month. This is such a recognizable credit card balance because it’s listed on your monthly statement and is the amount you need to pay in full, by the due date, or you’ll be charged interest. Your statement balance is a picture of all your card purchases, credits, payments, cash advances – if any – and transferred balances – if any – listed one by one as you made them, for an entire billing period.
As the name suggests, your average daily balance (ADB) is the average of all your daily credit card balances for a given billing period. The credit card company simply adds up all your daily balances for the monthly billing period and divides it by the number of days. What makes ADB important is that this is the balance used to calculate your interest charges should you ever carry a revolving balance.
If you don’t pay your entire statement balance by the due date, finance industry professionals say you “revolve” the unpaid portion. That’s your revolving balance – essentially, a loan. As with any loan, you’ll pay interest as explained more fully below. Two-thirds of actively used credit card accounts carry a revolving balance, according to a July 2019 report from the Consumer Financial Protection Bureau (CFPB).1
This is where the myth-busting comes in. People often ask, “Should I leave a balance on my credit card?” The myth is that carrying a revolving balance helps your credit score by demonstrating your ability to manage debt responsibly. But this is a costly mistake: When you revolve a balance you are taking out a loan, and now you must pay interest. While it’s true that your ability to manage debt responsibly is among the most important factors in determining your credit score, you demonstrate that simply by having a credit line and paying your bills on time. Paying the minimum due or paying the full statement balance has a similar effect on your score. For more about credit scores, read “What Affects Your Credit Score.”
Here’s how credit card interest is usually calculated if you revolve a balance:
Written like a formula, those three bullets look like this: ADB x DPR x Days in billing cycle = your interest charge. To translate that into dollars, consider this hypothetical example: Let’s say my September statement balance was $2,000 and I chose to revolve half by paying $1,000 on the due date. To oversimplify, let’s say I made no purchases since my last statement closed, so that my daily balance was always $2,000 until my payment. Running the formula on those numbers (and using the national average APR of approximately 17%) results in an interest charge of $26.08 on my October statement.
I would be charged interest all the way back to my last statement date, and if I had made additional transactions, I would have paid interest on those amounts, too, calculated from the day of each transaction. Looking ahead, I would continue to pay interest, compounded daily, until the next time I pay off a statement balance in full. That’s how, over time, carrying a revolving balance can add up to significant interest costs.
With at least five different possible definitions, it’s no wonder that “What is a credit card balance?” has such a lengthy explanation. Luckily, once you read the definitions of each, you can see how all the different balances relate to each other and contribute to the way modern credit cards work.