How a Certificate of Deposit Works
When you open a CD, you agree to leave a specific amount of money in the bank for a set period (the term). In exchange, the bank pays you a fixed interest rate that is typically higher than a regular savings account.
Key Factors in CD Growth
- Interest Rate (APR): The annual rate paid by the bank.
- Compounding Frequency: How often the bank adds interest to your balance (Daily, Monthly, etc.). The more frequent the compounding, the faster your money grows.
- APY (Annual Percentage Yield): The effective annual rate of return, taking the effect of compounding into account.
Understanding Compounding
Compounding occurs when the interest you earn begins to earn interest on itself. This is why the APY is usually slightly higher than the stated interest rate. For example, a 5.00% APR with monthly compounding results in a 5.116% APY.
What Happens at Maturity?
The maturity date is the end of the CD term. At this point, you can withdraw your initial deposit plus all the interest earned. If you withdraw funds before the maturity date, you will likely face an early withdrawal penalty, which often equals several months of interest.