What is the Nominal Interest Rate?
The interest rate that is offered to you without taking into account the effects of inflation is called the nominal interest rate. It is the rate that is used to determine how much interest you will pay on loan or how much interest you will earn on investments. You will pay 10% interest on the loan’s principle each year, for instance, if you take out a loan with a nominal interest rate of 10%. Your investment will grow by 5% annually if you place it in a savings account with a nominal interest rate of 5%.
The effect of inflation, or the rate at which the general level of prices for goods and services is rising, is not taken into account by the nominal interest rate. The buying power of the money you get from a loan or investment will be lower than the purchasing power of the money you paid out when the inflation rate is higher than the nominal interest rate. When comparing various loans or investments, the nominal interest rate might be helpful. Still, it’s crucial to take the real interest rate—which accounts for the impact of inflation—into account.
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.