Nominal Interest Rate

"Nominal" means "as stated". When a bank advertises a savings rate of 4% or a loan at 7%, that is the nominal rate. It is the starting point for most interest calculations, but it can hide important details.

First, the nominal rate does not account for inflation. If your savings earn a nominal 4% while prices rise by 3%, your money grows in number but only about 1% in purchasing power. The rate after inflation is called the real interest rate.

Second, the nominal rate does not always show the effect of compounding. A nominal rate of 12% compounded monthly produces an effective rate of about 12.68% over a year. To compare products fairly, people convert nominal rates into effective rates, such as APY for savings or EAR for loans.

So the same word has two contrasts. Nominal versus real is about inflation. Nominal versus effective is about compounding. In everyday conversation, the "interest rate" people quote is almost always the nominal one.