Nominal Interest Rate

What Does Nominal Interest Rate Mean?

The nominal interest rate of a loan or investment is the stated interest rate, not adjusted for inflation. It represents the numerical value of the interest but does not account for changes in purchasing power over time.

Insuranceopedia Explains Nominal Interest Rate

The nominal interest rate is the rate financial institutions offer clients for transactions like loans. It remains fixed for the duration of the transaction. For example, a $10,000 loan with a nominal annual interest rate of 5% will require a total repayment of $10,500 if paid off at the one-year mark.

However, for the lender, the real interest rate is lower if inflation occurs. While the lender earns a $500 profit, the purchasing power of that $500 may diminish compared to its value at the time the loan was issued.

The same gap between nominal and real returns affects insurance products that pay or credit interest. The rate quoted on an annuity or the cash value of a universal life insurance policy is a nominal figure, so a 4% credited rate can mean less in actual purchasing power if inflation runs high while the policy is in force.