Nominal interest rate
The stated annual rate on a loan before fees, as distinct from the effective rate.
The nominal interest rate is the annual rate on a loan or an investment before any fees and other costs are added. This rate gives a picture of what it costs to borrow money in the form of interest, but it does not include other costs such as instalment fees or arrangement fees. The nominal rate can therefore be somewhat misleading for borrowers when they are assessing the cost of a loan.
Why does the nominal interest rate exist?
The nominal rate is often used in the marketing of loans in order to attract potential borrowers by highlighting a low rate. Since it does not include additional costs, it can appear lower than the actual cost of the loan. This makes it important for borrowers to be alert and to compare the effective rate, which includes all fees and gives a more accurate picture of the total cost of the loan.
Effective rate vs. nominal rate
The nominal rate shows only the basic interest cost, whereas the effective rate includes all additional fees and costs. For example, if a loan has a nominal rate of 5% but also includes instalment fees and arrangement fees, the effective rate may end up being 6% or higher. The effective rate therefore gives a better basis for comparing different loan offers.
More terms in returns and investment analysis
See all →ROE (return on equity)
Measures the return a business generates on the equity its shareholders have invested.
ROA (return on assets)
Shows how efficiently a business uses its total assets to generate profit.
ROCE (return on capital employed)
Measures the return on all capital in the company, both debt and equity.
ROI (return on investment)
Measures the profitability of an investment relative to what it cost.
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