Why is the APY on my statement not the same as the APY shown on my Certificate of Deposit? The answer is: It’s the math! The law requires that we disclose interest (dividend) rates for certificates of deposit two ways: (1) Annual Percentage Rate (APR) and (2) Annual Percentage Yield (APY). The APR is the stated dividend rate, such as 3.0%; the APY shows the effect of compounded dividends over a one-year period. What is compounded interest? Compounded interest is interest that is added back to the principal of the certificate of deposit so that it can earn additional interest during the next compounding period. For example, a one-year certificate for $1,000 at 3.0% simple interest, that is interest paid at the end of the year only, would earn $30.00. A one-year certificate that compounds interest monthly would earn $30.43 for the year. For this certificate, the APR is 3.0% and the APY is 3.04%. The formula for calculating interest is (PxR)xT, principal times the rate times the time factor. The simple interest example above is calculated $1,000 x 3.0% x 1 (one year) = $30.00. The compounding interest example is more complicated because the monthly interest must be calculated and added to the balance and then the new balance used for the principal in the next month’s calculation. If the certificate was purchased on January 1, the interest at the end of January is calculated using this formula: $1,000 x 3.0%/365 x 31 = $2.55. In this calculation the interest rate of 3.0% is divided by 365 (days in a year) to determine the daily interest rate and the number of days in the month of January is multiplied time the daily interest rate to arrive at the monthly interest amount of $2.55. The February interest is calculated using this formula: $1,002.55 x 3.0%/365 x 28 = $2.31. $1,002.55 is the new balance because of the addition of the January interest, the daily interest rate is still 3.0% divided by 365, and the number of days in February is 28. The APY shown on members’ statements is based on the interest payments for the quarter being annualized and then divided by the original amount of the principal. In our compounding interest example above, the March interest is $2.56 and the total interest paid on the certificate for the quarter is $7.42. $7.42 annualized is $7.42 x 4 (quarters in a year) = $29.68 and the resulting APY is 2.97% ($29.68 divided by $1,000). How can an APY of 2.97% be an APY of 3.04% when it is even less than the stated APR of 3.0%? Under our compounding example above, the APY for the first quarter is 2.97%, the APY for the second quarter is 3.02%, the APY for the third quarter is 3.08%, and the APY for the fourth quarter is 3.10%. The average of the four quarter APYs is 3.04%. The total interest paid for one year is $30.43, which divided by the $1,000 original principal is 3.04%, the stated APY.
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