When taking out a loan it is important to keep track of the nominal interest rate. It sounds awfully complicated, but it’s not at all as difficult as it sounds. Read this article and you will know everything you need to know about nominal interest rates in about 4 minutes!
What is the nominal interest rate for something?
The nominal annual interest rate is the interest rate that you usually refer to when discussing and reading about different loans. It usually appears clearly in the advertisements for loans and stands with large numbers in front of the percent sign. The easiest description is the nominal interest rate, the percentage of the total debt that you have to pay to the lender each year.
The difference between the nominal interest rate and the effective interest rate
The effective interest rate is always included in advertisements for loans, however, it is often difficult to see. It is always higher than the nominal interest rate for several different reasons and is therefore often hidden in the fine print. However, according to the Consumer Credit Act, it must always be associated with advertising for loans.
The formula for calculating effective interest rates on your own is more complex than you might think. This is because the effective interest rate, in addition to the usual nominal interest rate, also includes fees that are normally included in the loan. If the loan has a set-up fee, avi-fees or other additional costs, then these are included in the effective interest rate. Difference from the nominal interest rate where they are not visible at all. This means that the nominal interest rate is often misleading when comparing different loan offers. You can calculate the effective interest rate using our loan calculator.
How do I calculate the nominal interest rate?
Let’s say you borrow USD 100,000 in the form of a mortgage loan. You get an interest rate on the loan of 3% annually. Then the nominal interest rate is also 3%. In USD you will then pay USD 3000 in nominal interest per year.
If there are additional fees for, for example, the arrangement of the loan and the announcement, the effective interest rate will be higher than these 3%, since the effective interest rate takes into account both the nominal interest rate and the fees. If you borrow USD 100,000 for five years, at an annual nominal interest rate of 3%, but there is an additional fee of USD 300 and a monthly fee of USD 29 each month, the effective interest rate will be 3.84%.
Why is effective interest always higher than nominal interest rate, even without any fees?
When you talk about interest, you usually mean annual interest in%. With regard to interest rates on interbank loans, the country usually pays interest costs together with monthly repayments. The monthly repayment means that the debt becomes smaller and smaller each month. To compensate for the loan being paid monthly, the lender is therefore forced to charge a higher effective interest rate. This is so that the sum of this year’s interest payments will match the nominal annual interest rate. The correct term for this phenomenon is compound interest.
Benefits of comparing the banks
In this section you have learned more about nominal interest rates. To find the loan with the lowest interest rate, both nominal and effective, it pays to compare the banks with the help of loan comparator. All banks specialize in different types of customers. It is therefore not possible to say that one specific bank is better than another in advance. This is why it is important to compare different loan offers to find which bank suits you best!
If you as a private individual go to several different banks to compare the terms, they each take credit information on you. This affects your credit rating and can impair your ability to get a really low interest rate. If you choose to compare , only one credit report is made. The service is completely free of charge and you do not commit to anything when you make a comparison. Instead, Loan comparator gets paid directly by the bank or lender when we can help them get a new satisfied customer.