Interest

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Judith Gotin
Judith Gotin's picture
Interest

whats the difference between nominal interest and compound interest?

Jason Pride
Jason Pride's picture

Hi Judith,

Nominal interest is basically the stated interest rate without any adjustments for inflation or compounding.
Compound interest is the effective interest when the sum is compounded over time. When interest is compounded it is calculated more frequently than the nominal interest terms. While the nominal interest rate may be stated as 10% annually, the interest may be calculated monthly or weekly. The end result is that the interest payment changes from period to period.

For example if you have a 10% interest rate on a $100 investment the compound interest may be different than the nominal interest. If the interest is paid only at the end of the year then you will be paid $10 and the effective interest rate will be the same as the nominal rate. However, if the interest is paid monthly then you will receive $0.83 ($100*(10%/12)) the first month and each additional month you will be paid interest on the original investment and the previous interest earned.

Jason Pride
Jason Pride's picture

Hi Jerry,

When you take a personal bank loan you are paying a compounded rate, but in reverse. Each payment includes interest and principle, but the interest portion of the payment reflects only the outstanding principle balance and not the original loan amount. Some business loans are structured differently and may pay flat interest payments similar to a bond.