CD (Certificate of Deposit) interest accrues and compounds over time, meaning you earn interest not only on your initial deposit but also on the accumulated interest.
Here's a more detailed explanation:
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Initial Deposit: You start by depositing a sum of money into the CD.
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Interest Rate: The CD has a fixed interest rate, which determines how much interest you will earn.
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Compounding: This is the key to how CD interest grows. Compounding means that the interest earned in one period is added to the principal, and then the next period's interest is calculated on the new, larger principal. For example, if you have a CD with a 5% interest rate compounded annually, and you deposit $1,000, at the end of the first year, you'll have $1,050. In the second year, the 5% interest is calculated on $1,050, not just the original $1,000.
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Compounding Frequency: Compounding can occur at different intervals, such as:
- Daily: Interest is calculated and added to the principal every day.
- Monthly: Interest is calculated and added to the principal every month.
- Quarterly: Interest is calculated and added to the principal every three months.
- Annually: Interest is calculated and added to the principal once a year.
The more frequently interest compounds, the more interest you will earn over the life of the CD, assuming the same stated interest rate.
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Maturity Date: CDs have a maturity date, which is when the term of the CD ends and you can withdraw your principal and accumulated interest. If you withdraw your money before the maturity date, you will typically incur a penalty.
In summary, CD interest accrues by calculating interest on the principal plus previously earned interest, with the compounding frequency impacting how quickly your earnings grow.
