Is a Bank’s Loan Interest Rate Nominal or Real?
A nominal interest rate is frequently used when quoting a bank’s interest rate on a loan. The interest rate that is offered to you without taking into account the effects of inflation is called the nominal interest rate. The rate is used to figure out how much interest you’ll pay on a loan. The nominal interest rate can be either constant or variable and is stated as an annual percentage. In contrast to variable interest rates, which can change over time, fixed interest rates guarantee that the interest rate will not change over the loan’s tenure.
It is crucial to remember that the nominal interest rate, which measures how quickly prices for goods and services are rising, does not account for inflation. The real interest rate, which accounts for the impact of inflation, is negative when the nominal interest rate is higher than the inflation rate, which indicates that the buying power of the money you receive from the loan will be lower than the purchasing power of the money you paid out.
For instance, the real interest rate would be negative 1% if you took out a loan with a nominal interest rate of 5% and the inflation rate was 6%. As a result, the money you borrow will have a lower purchasing power than the amount you pay back.
Nominal vs Real Interest Rates
The portion of a loan that is charged to the borrower is called an interest rate, and it is often stated as an annual percentage. Lenders utilize interest rates to cover the risk they assume when making loans, and they can also be used to help keep inflation under control.