Banks offer a number of different kinds of interest bearing accounts. On some accounts you earn a fixed interest rate for a specific number of years, while on other accounts the interest rate may change on a monthly or even weekly basis. Federal regulation DD requires banks to disclose information to consumers about how interest rates are computed on all types of interest-bearing accounts.
Fixed Rate Certificates Of Deposit
On a certificate of deposit, banks use the daily balance method to determine your interest. The bank agrees to pay you a particular interest rate, which it refers to as the annual percentage rate. The bank divides that rate by the number of days in the year. If you have a $100 CD and an annual interest rate of 3.65 percent, then you earn 1/365 of the annual interest on each day of the year. In this instance you would earn $0.01 on a daily basis which means that you earn $3.65 or 3.65 percent by the end of the year. Banks normally credit interest to the account on a monthly basis, annually or at maturity.
On a variable rate CD, your bank calculates interest in the same manner as on a fixed rate CD except that the annual percentage rate can change over the course of the CD term. Some banks offer so-called "step rate" CDs on which your interest rate increases every quarter. Other banks offer variable rate CDs on which the bank can change the rate at any time. You earn the initial interest rate using the daily balance method until the bank changes your rate. Thereafter, you continue to earn interest on a daily basis but at the new rate.
Some banks and brokerage firms sell market-linked CDs that track the performance of stock market indexes such as the Dow Jones Industrial Average. In many instances, you only receive a return if the index rises above a certain level -- and if it does, you typically earn a flat rate of interest. Your bank may agree to pay you 5 percent if the market rises over the course of the year but you receive nothing if the market stays flat or declines. Most market-linked CDs pay simple interest rather than compound interest. This means that if the market rises, your bank multiplies your CD balance by 5 percent and you receive a check for that amount. The bank does not add the interest to your account balance.
Bank savings, money market and checking accounts also use the daily balance method to calculate your interest. Typically, these accounts have variable interest rates. While you earn interest on a daily basis, your bank may opt to credit your interest to your account on a monthly or quarterly basis. However, when you deposit a non-cash item such as a check, into a CD, you begin to earn interest on the day of the deposit. With other types of accounts, you do not begin to earn interest until your bank has actually collected funds from the check writer's bank.
If you violate federal regulation D by frequently making more than six monthly withdrawals from your savings account, your bank can convert your savings into a non-interest-bearing account. On a CD, your bank can assess an interest penalty if you withdraw your funds before the end of the CD term. Penalties vary from bank to bank but can amount to several months of interest. When a CD matures, the interest rate drops to the default rate so you do not continue to earn interest at the same rate that your account earned during the actual CD term.
- Bank of America: Deposit Agreement and Disclosures
- Securities and Exchange Commission; Equity-Linked CDs; October 2006
- Comptroller of the Currency Administrator of National Banks: Answers about Interest-Bearing Accounts
- The Board of Governors of the Federal Reserve System: Regulation DD Truth in Savings
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