What is Nominal Interest?
Nominal interest is the most basic form of interest, and the simplest to calculate. Nominal interest determines the price that we must pay for a one-year loan, and the amount of interest paid at the end of the year.
(The word “nominal” means “unadjusted.” In the context of loans and interest rates, “nominal” refers to an amount before it is adjusted for compounding frequency. “Nominal,” in a macroeconomics context, refers to an amount before it is adjusted for inflation.)
For example, an 8% nominal interest rate means that if we have received a loan of a certain amount, for example $10,000, we will have to pay 8% of the principal at the end of the year, i.e. $800. If the loan is of shorter duration, we will pay accordingly.
Each of the following calculation methods (compound interest, adjusted interest, and effective interest) is based on a rate of nominal interest that is specified in the next pages.