How CD Interest Works: APY, Compounding and What You'll Actually Earn

A certificate of deposit (CD) is a savings account with a fixed term and, usually, a fixed rate. You agree to leave the money for a set period, from a few months to several years, and the bank pays a higher rate than a regular savings account in return. Here's how that interest is calculated.

Interest rate vs. APY

Banks quote two numbers:

Interest rate (sometimes called the nominal rate or APR): the yearly rate before compounding.
Annual percentage yield (APY): what you actually earn in a year once compounding is included.

US banks are required to disclose APY on deposit accounts, which makes it the fair number for comparing CDs. If two CDs have the same APY, they pay the same over a year regardless of how often they compound.

Compounding

Compounding means interest is added to your balance and then earns interest itself. The more often it compounds, the higher the APY for a given nominal rate:

Nominal rate 4.50%	APY
Annually	4.500%
Quarterly	4.577%
Monthly	4.594%
Daily	4.602%

The difference between monthly and daily is tiny; the difference between the best and worst CD rates on the market is far larger.

The formula

balance = deposit × (1 + rate ÷ n)^{n × years}

Using APY instead: balance = deposit × (1 + APY)^years.

Example: $20,000 in a 2-year CD at 4.20% APY. Balance = 20,000 × 1.042² = $21,715.28, so you earn $1,715.28. The CD calculator handles any term and compounding schedule and shows the balance month by month.

Terms shorter or longer than a year

APY is an annual figure. A 6-month CD at 4.00% APY earns about half a year's worth: 1.04^0.5 − 1 = 1.98%, or $198 on $10,000. A 5-year CD at 4.00% APY grows to 1.04⁵ = 1.2167 times the deposit, a 21.67% total return.

How interest is paid

Most CDs credit interest to the CD itself, where it compounds. Some let you have interest paid out monthly or quarterly to another account. Paid-out interest doesn't compound, so your total earnings are slightly lower, but it provides income.

What reduces your return

Early withdrawal penalties; see CD early withdrawal penalties.
Taxes on the interest; see how CD interest is taxed.
Inflation: if inflation runs at 3% and your CD pays 4%, your purchasing power grows by only about 1% a year.

Safety

CDs at FDIC-insured banks are covered up to $250,000 per depositor, per insured bank, for each account ownership category. Credit union share certificates have equivalent NCUA coverage. Within those limits, your principal and earned interest are protected even if the institution fails.

Educational content only, not financial advice. Rates and terms vary by institution.