Short Term CD Interest Earned Question

stcharles | Mar 25, 2018 | 22 posts since 2018

I've never had a 12 mo. or less CD I would like to know if this is standard policy for short-term CD's.

Looking at Crestmark Bank - Crestmark Bank has raised the rates on its nationally available 6-month CD (2.00% APY), 9-month CD (2.05% APY), and 12-month CD (2.20% APY). $25k minimum deposit.

A poster noted they do not compound interest - is this standard policy on short term CD's? Or lets say you purchased 6 month. $25,000 CD how much interest would you lose if it didn't compound over 6 months?

Thanks for your help.

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Answers

Anon456 | Mar 27, 2018 | 249 posts since 2011

The difference on $25K between compounding or not on 6 months is just a noise number. Just compare APY from one source to another and that is the real answer you want.

me1004 | Mar 25, 2018 | 1,379 posts since 2010

Banks and credit unions can compound or not as they please, they simply must tell what they do and how they calculate it, and provide the effective APY (annual percentage rate). The APY is the real amount you will get if on deposit for a year, and that is the number that is most important. How often they compound is taken into consideration in that.

However, as math goes, if there is no compounding, then it is simple interest, and gets the APY all through the the, whereas with compounding it takes incremental increases all through the year to finally reach the APY. As such, an APY from no compounding and for only six months is worth more than the same APY via compounding but for only a six-month term.

Sorry, I'll bet that is confusing to follow, But in the end, it means you are doing better at the six-month term to have no compounding at that APY.

stcharles | Mar 26, 2018 | 22 posts since 2018

Thank you me1004 for your reply. I think I understand and will copy your reply to my notes in case I need to refer to it again.
Is there a way I could see the actual interest amounts of say $25,000 6 mo. CD that offers compounding vs. one that doesn't? Am I correct that the 6 mo. CD if offering compounding would pay the interest monthly, thus 6 payments for the 6 month term?

stcharles | Mar 26, 2018 | 22 posts since 2018

Sorry in my previous note asking about compounding I should have added a $25,000 CD for 6 mo. at 2.00% APY. thanks again.

RJM_Willy12 | Mar 26, 2018 | 149 posts since 2016

Google "interest rate verus apy"

me1004 | Mar 26, 2018 | 1,379 posts since 2010

stcharles, different banks and CUs compound differently, so APY is the best way to compare, or you can ask them to tell you the final interest amount you will accrue by maturity. But to give you that number, they might simply do a little mat h of their pwn that you could do yourself -- that is, their calculation might simply be no less approximate than your's.

Some compound daily, some monthly, some quarterly, some, as we have already addressed, use simple interest, no compounding, so the rate and APY would be the same. Some calculate daily compounding on the basis of 356 days, some on the basis of 364 days, and who knows what other numbers. Some offer a 12-month CD and some offer a one-year CD, but they will mature on different days. The number of days on which the compounding is calculated might not change for leap year, so that year you get one day more interest for the year.

This is one reason why the regulators now require banks and CUs to provide the APY. Banks were using all these variations to trick people when telling them the rate; a rate of 5.0 percent might have yielded you less than a rate of 4.8%. So the regulators required divulging the APY as basically the only truthful information. Seems to me that regulation was imposed in the 1980s.

me1004 | Mar 27, 2018 | 1,379 posts since 2010

correction, paragraph two should read 365, not 356 -- the numbers got transposed.

enelrad1123 | Mar 27, 2018 | 75 posts since 2017

Another angle to consider is that when the monthly interest earned on your CD is wired to another interest bearing account, such as a high yielding savings or money market account, you are earning interest on your interest. This results in a slightly higher APY than the stated APY. You really aren't losing interest by not compounding and you have control (and access) to the interest earned on the CD. I had a one year CD with Crestmark and had my interest wired to a money market that was earning 1.55%, so I earned interest on my interest.

RJM_Willy12 | Mar 27, 2018 | 149 posts since 2016

Your comment is exactly the opposite of what actually happens.

There is an interest rate and an APY. The interest rate is a simple rate. APY assumes the interest paid is reinvested at the same interest rate. If the bank compounds, the two rates will vary, and the APY will be higher.

If instead you withdraw the interest and put it into a lower interest rate savings account, you will have earned the CD interest rate, plus the savings account interest, which will be less than the APY.

When setting up a CD, the logical approach is to have the interest reinvested into the CD, and then withdraw it and reinvest elsewhere, if interest rates increase and the interest can be reinvested at a higher rate than the existing CD.

me1004 | Mar 27, 2018 | 1,379 posts since 2010

bliss_ignorant , I believe enelrad1123 was referring to CDs earning simple interest. And he/she makes a good point -- to a point. In theory, with no compounding under simple interest, if you withdraw the interest as it is posted, you can then put that in another account that does draw interest.

But actually, that would only be correct if the simple interest were posted only at time of maturity -- and that often is the case with simple interest. But in that case, there would be no interest available through the term of the CD to reinvest.

But some banks that call what they pay simple interest actually will pay it out annually or even quarterly, and so that would then be in the CD to earn interest. That would not really be pure simple interest unless there were a rule going along with it that no interest would subsequently accrue on posted interest, only on principle.

And that raises another point: When it is simple interest, especially when paid only at maturity, you can get a tax deferral on it, as you pay taxes only on the interest that is posted in a year. So, let's say you open a one-year CD in June. It would not mature until the following June, and it would pay all interest at maturity. Well, that would mean that in the year you opened it, no interest was posted and so no taxes due on what was accrued. You can keep the money you would have paid in taxes and invest it for another year.

RJM_Willy12 | Mar 27, 2018 | 149 posts since 2016

me1004, what a mess.

Not really worth the effort to untangle it.

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