The monthly rate paid for a CD each month is calculated by
the percentage of interest, divided by the number of months.
In this example, 6% interest on a 12-month CD pays 6% ÷ 12, which
equals .5% per month. That rate is paid to the account each month.

Compounding of CD Interest- Example.png


Since CDs are fixed and you cannot withdraw the money each month
(without paying a penalty), this additional interest earned
is added to the balance at the end of each month.

Compounding of CD Interest- Month 1.png


At the end of the second month, the .5% rate is paid on the
original amount plus the additional interest paid last month.
In other words, as interest is earned, the value of the CD
grows each month. That new higher value then earns
more interest in the following month.

Compounding of CD Interest- Month 2.png


By the end of the 12 months, you will have more money in the account
than if the bank only gave you 6%. This adding of the monthly interest
to each month and paying the.5% on the new balance gives a small
additional sum above the 6% at the end. This new amount is then
converted to a rate and that rate is called the APY.


A CD’s interest rate will be stated in two ways:
1) the interest rate, and
2) the Annual Percentage Rate (APY).

The APY will always be slightly higher than the interest rate.
In this example, if you have a 12-month CD, and the interest rate is 6%,
the APY will be 6.16%. These bank percentages are
always stated as annual percentage rates.