Nominal interest is one way of describing interest payable by a borrower. The other way of describing interest is effective interest.
Nominal interest can have the unintended effect of understating the interest payable to CRE players.
Example of nominal interest
A lender lends money at 12% p.a. nominal.
The monthly interest calculation is therefore 12% / 12 months = 1%.
However, 12% is not what you, as the borrower will pay on a yearly basis.
Because interest generally compounds, the effective interest rate is 12.683%.
That is because the interest compounding monthly at 1% results in “interest on interest”.
The calculation for this is [ (100% + 1%) ^ 12 ] – 100%
Quick calculations using Excel
To convert nominal interest to effective interest, where nominal interest is expressed as an annual value: = (1 + (annual interest rate / 12 months) ^ 12) – 1
To convert nominal interest to effective interest, where nominal interest is expressed as a quarterly value: = (1 + (quarterly interest rate / 3 months) ^12) – 1
To convert effective annual interest to nominal: = (1 + effective annual interest rate) ^ (1 / 12) x 12 months. The first part gives you the monthly rate. The second part transforms it into nominal
