Previous Balance Method

What Is the Previous Balance Method?

The term "previous balance method" describes one of many methods for calculating interest payments that are used by credit card companies. Under the previous balance method, the amount of interest charged each month is based on the balance of debt outstanding on the card as of the beginning of the previous month.

Generally, the previous balance method is favorable to the credit card company and unfavorable to the borrower. This is because, for customers who are working to gradually pay off their debts, this method would not acknowledge the debt repayments that are made during the course of the current month. Instead, the monthly interest will be based only on the balance as of the start of the month, before those repayments are made.

Understanding the Previous Balance Method

Credit card companies have many methods to choose from when deciding how to calculate their cardholders' monthly interest payments. For example, they might choose to calculate interest based on the first day of the month, the last day of the month, or some average of the two. Some cards even calculate interest once each day, and then either charge the customer on a daily basis or else at the end of the month.

Depending on the spending and repayment patterns of the borrower, different interest calculation methods may be preferable. For instance, customers who make partial repayments throughout the month on their outstanding credit card debt would likely wish to avoid the previous balance method. However, customers who pay off their entire balance each month would be indifferent toward the interest calculation method used, since they would not end up paying interest either way.

Savvy credit card customers will consider the card's interest accounting methodology when deciding on which card to accept. After all, credit cards tend to offer trade-offs between various features that are desired by customers, such as offering a higher annual percentage rate (APR) in exchange for a more generous rewards program.

Interest accounting methods are one of the many ways in which credit cards can differ, along with credit limits, account fees, and other such features.

Apart from the previous balance method, other common methods of interest accounting include the ending balance method, in which monthly interest is charged based on the balance remaining at the end of the prior month; the average balance method, in which it is based on an average between the beginning and ending balance; and the daily balance, in which interest is charged each day.

Example of the Previous Balance Method

Emma is considering selecting a new credit card. When reviewing her options, she notices that the cards differ substantially based on factors such as their approved credit limits, account fees, APRs, reward systems, and even their interest accounting methods.

Emma determines that the most important features for her are that the card has an attractive reward system and no account fees. Because she uses her credit card as a "charge card" — paying off the full balance each month — she can afford to accept a card with a higher APR in order to get the features she finds most important. Similarly, because she does not carry any outstanding balance from month to month, she does not pay any interest on her credit card and is therefore indifferent as to its interest accounting method.

For these reasons, Emma selects a credit card with a high APR calculated based on the previous balance method. Because these features are unattractive to most credit card users, the card offers a very generous reward program and charges no account fees. If Emma did not use her credit card as a charge card, she would likely have preferred a card that calculated its interest payments based on the ending balance method, so that the repayments she makes during the month would be reflected in a reduced monthly interest charge.