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Definition, how they are defined, example

  • The nominal interest rate is the interest rate before adjusting for inflation.
  • As a consumer, you are more likely to see nominal interest rates quoted when shopping for credit or a savings account.
  • The nominal interest rate serves as the basis for calculating other types of interest rates.

Interest, by its simplest definition, is the commission attached to money, whether it is borrowed, lent or invested. However, there are several different types of interest rates, and your projected costs or returns may be very different depending on which one you are considering.

The nominal interest rate is what you will commonly see listed at your local bank or credit union.

What is a nominal interest rate?

The nominal interest rate is the interest rate before adjusting for inflation. This is the rate that financial institutions often advertise for things like bank loans, mortgages, and savings accounts.

Although the nominal interest rate reflects borrowing costs on loans and savings returns, it does not give the full picture. Without accounting for inflation, actual costs or returns can vary significantly as the purchasing power of money changes over time.

When nominal interest rates are used

As a consumer, you are more likely to find nominal interest rates when shopping for credit or looking to put money in an interest-bearing account. You’ll also likely see other types of interest rates, including annual percentage yield (APY) and annual percentage yield (APR), which take other factors into account, including the effect of compounding and non-interest costs associated with a loan.

“A nominal interest rate is the face value of the interest you pay on a loan,” says Nicholas Creel, assistant professor of business law at Georgia College and State University.

The nominal interest rate serves as the basis for calculating other types of interest rates.

How are nominal interest rates set?

When the Federal Reserve sets the federal funds rate, the rate acts as the nominal short-term interest rate. It serves as a benchmark for interest rates charged by lenders and earned by savers.

Banks and other lenders take projected inflation rates into account when setting their nominal interest rates. They set prices that allow them to make money from their products and services and adjust them regularly. Here is the basic formula:

Nominal interest rate = real interest rate + expected inflation

Banks in the United States react to short-term rates set by the Fed and adjust their nominal interest rates accordingly when they change. However, actual interest rates will vary from bank to bank.

While the federal funds rate plays a role in all of them, each bank’s nominal interest rates will also take into account its own operating costs and other factors to determine a rate that is both competitive and profitable. . Be sure to shop around for the best deal.

The nominal interest rate allows you to compare the opportunities between loan products and savings accounts. However, you will need to determine the actual interest rate to understand the impact of the loan product or savings account on your purchasing power.


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