How CD interest is calculated
A certificate of deposit pays a fixed interest rate for a fixed term. The money compounds, meaning each period's interest is added to the balance so the next period earns interest on interest. The formula is:
A = P(1 + r/n)^(n x t)P is your deposit, r the annual rate, n how many times a year it compounds, and t the term in years. The more often it compounds, the more you earn, which is why banks advertise APY (annual percentage yield), the true yearly return after compounding, rather than the plain rate.
APR vs APY
A 5% rate compounded monthly is actually a 5.12% APY because of compounding. When comparing CDs, compare APYs, not headline rates, since two CDs with the same rate but different compounding pay different amounts. This calculator shows both so you can see the gap.
Before you lock in
- CDs charge an early-withdrawal penalty, so only deposit money you won't need until maturity.
- CD interest is taxable each year as ordinary income, even before the CD matures.
- A CD ladder (several CDs maturing at staggered dates) keeps part of your money accessible while still earning.