Nominal Interest Rate Definition

See Also:
What is Compound Interest
Effective Rate of Interest Calculation
Interest Expense
When is Interest Rate Not as Important in Selecting a Loan?
Interest Rate Swaps

The Nominal Interest Rate Definition

A nominal interest rate is the interest rate rate quoted on lending and borrowing transactions. Nominal rates represent the rate of exchange between current and future dollars, unadjusted for the effects of inflation. Since nominal rates are not adjusted for inflation, they do not convey the prices of lending and borrowing transactions as accurately as real interest rates.

Nominal Interest Rate, Real Interest Rate

Nominal interest rates are not adjusted for inflation. Whereas, real interest rates are adjusted for inflation. Make the adjustment with current or projected inflation rates. Furthermore, real interest rates offer a more accurate representation of the prices of lending and borrowing transactions. To calculate real interest rates, use the following formula:

Real Interest Rate = Nominal Interest Rate – Inflation Rate

For example, if a lender offers a loan with a nominal rate of 5% and the inflation rate is 3%, then the lender will earn real interest of 2%. However, if the inflation rate is 7%, then the lender will essentially be losing value on the loan.
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