Legal Definitions - nominal rate

The nominal rate refers to the stated or advertised interest rate on a loan, investment, or savings account, without accounting for the effects of inflation or the frequency of compounding interest. It is the face-value rate that is typically quoted before any adjustments are made for the true purchasing power of money over time or the actual annual return/cost due to compounding.

• Example 1: Mortgage Loan

  Imagine a bank advertises a 30-year fixed-rate mortgage with an interest rate of 6%. This 6% is the nominal rate. It's the rate used in the initial calculations to determine your monthly payments. However, it doesn't reflect how inflation might erode the purchasing power of the money you pay back over three decades, nor does it necessarily represent the true annual cost if other fees or compounding periods are factored in (which would lead to an Annual Percentage Rate or APR).

• Example 2: Savings Account

  A credit union promotes a new savings account offering an annual interest rate of 2.5%. This 2.5% is the nominal rate. Even if the credit union compounds the interest monthly, meaning you earn a small portion of that 2.5% each month on your balance, the stated annual rate remains 2.5%. The nominal rate is the headline figure you see in advertisements or account descriptions.

• Example 3: Corporate Bond

  A large corporation issues a bond with a coupon rate of 3.75%. This 3.75% is the bond's nominal rate. It represents the percentage of the bond's face value that the company promises to pay to the bondholder annually. This rate is fixed at the time of issuance and is the stated return, regardless of market fluctuations or inflation that might affect the bond's real value or yield to maturity.