Home Equity Loan
Nominal Interest Rate
A nominal interest rate is the interest rate that does not compensate for
inflation.
Effective interest rate
When comparing interest rates, nominal interest rates and effective interest
rates have to be distinguished. An interest rate is called nominal if the period
of time after that the interest is credited (e.g. a month) is not identical to
the basic time unit (normally a year).
For example, let's assume a nominal interest rate of 6% which is credited as of
6%/12 = 0.5% every month. After one year, the initial capital is increased by
the factor (1+0.005)12 ≈ 1.0616. As a result, this nominal interest rate is
equivalent to an effective interest rate of 6.16%.
Real interest rates
Interest rates compensate the lender for postponing access to the money. This includes taking account of likely changes in the value of money over time due to price inflation. If the nominal interest rate is adjusted to ignore this change, what remains is called the real interest rate.