How to Figure Out Interest Rates for a Certificate of Deposit
A Certificate of Deposit (CD) generally has a high interest rate, making it one of the best choices for a savings account. However, it can be difficult to know the true value of a CD, since banks sell CDs with various durations and various interest rates. To find out if your CD's interest rate is worth your investment, you need to figure out your CD's Annual Percentage Yield (APY). Once you know how to calculate the APY, you'll instantly be able to choose the most high-yield CD.
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Instructions
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Consider the duration of your prospective CDs. CDs can stay in the bank from a week to several years. That means a CD with an APY of 2 percent will give different yields for 1-year or 5-year accounts.
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Find out the APY of your prospective CDs. The APY is the rate of compounded interest, which basically means you earn interest on your interest rate from your bank.
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Consider the rate at which the banks compound interest. Banks may compound interest daily, monthly or quarterly. You'll generally get the highest APY on longer CDs, which gives you more money. You'll also earn more if your interest compounds daily as opposed to monthly or quarterly.
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Learn the APY formula, also called the Effective Annual Rate (EAR) calculation, to calculate your CD's APY. The formula is as follows: APY = P(1 +r/n) to the nth power minus 1. Here, P stands for your initial deposit, r stands for the annual interest rate, and n is the number of times the interest is compounded per year. For instance, if you have a 1-year CD that is compounded monthly, n stands for 12.
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Use the APY formula on the CDs you are considering. The APY will allow you to compare widely different CDs since it gives you the actual annual interest rate on each of these CDS. Thanks to this formula, you'll know you're choosing the most investment-worthy CD.
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Tips & Warnings
For CDs, it is not necessary to consider the Annual Percentage Rate (APR). APR only tells you the yearly interest rate without compounding, so you don't glean from it the true value of your CD.
