How CD interest is calculated
A certificate of deposit locks your money away for a fixed term at a fixed rate. Interest compounds at the frequency set by the bank, and the balance at maturity is:
A = P(1 + r/n)^(n·t)
The annual percentage yield (APY) shows the true one-year return after compounding, which lets you compare CD rates fairly:
APY = (1 + r/n)^n − 1
- P — deposit; r — nominal annual rate; n — compounding periods per year; t — term in years
Early withdrawal penalty
Most banks charge a set number of months of simple interest if you withdraw before maturity: Penalty = P × r × (months ÷ 12). If you withdraw very early, the penalty can be larger than the interest you've earned and eat into your deposit.
Worked example
$10,000 in a 12-month CD at 5% compounded annually matures at $10,500. With monthly compounding the APY rises to 5.116% and you'd receive about $10,511.62. Cashing out at month 6 with a 3-month penalty costs $125.
Key terms
- CD / GIC / fixed-rate bond
- The same idea under different names: a CD in the US, a GIC in Canada, and a fixed-rate savings bond in the UK.
- APY / AER
- The effective yearly rate including compounding. Called AER in the UK.
- Maturity
- The date the term ends and you can withdraw penalty-free or roll into a new CD.
- CD ladder
- Splitting money across CDs with staggered terms so part of it matures every few months.
- Deposit insurance
- FDIC (US, up to $250,000), FSCS (UK, up to £85,000) and CDIC (Canada, up to $100,000 per category) protect eligible deposits.