Reg DD question

I am having difficulty determining when you use "average daily balance method" or calculating interest or when you use "daily balance method"

I have read the definitions in the reg and appendix A which really didn't help too much.

If you are compounding daily and paying monthly; which method should you be employing? I don't see where there is much difference on which method you use.

I need to go to the specs for the particular account type as a next step.

Can anyone give me a better definition on the two methods?

With the daily balance method, interest is calculated each day and added to a "bucket" for posting. At posting time, the bucket is emptied. Fractions of cents usually sit in the bucket for the next interest period's accumulation.

With the average daily balance method, interest is not calculated until it's time to post. The daily balance is added to a "bucket" each day. At interest calculation time, the total of the bucket amount is divided by the number of days in the interest period to arrive at the average daily balance. Then interest is calculated using that number.

For most accounts, the difference in the results between the two methods shouldn't amount to much. Any difference could be attributed to the rounding of fractional cents when using the daily balance method.

The real difference between the two methods would come into play on a couple of situations. On tiered rate accounts, one method would pay on the daily balance for the specific tier based on the daily balance of the account - it could be a range of rates over the month. The other method would pay one rate based on the average balance for the whole month. Also, if you paid on the average daily balance, you could not base the payment of interest for the month on the requirement that the account maintain a minimum daily balance for every day during that month. (See commentary at 230.7(a)(2))

On a straight fixed - one rate - account, there is really no difference between the two methods as John pointed out..