Given a fixed interest rate of 5%, the actual cost of the loan, with principal and interest combined, is $10,500.This is the amount that must be paid back by the borrower.Interest rates can fluctuate, too, and that's exactly what can happen with variable interest rates.Variable interest is usually tied to the ongoing movement of base interest rates (like the so-called "prime interest rate" that lenders use to set their interest rates.) The annual equivalent rate (AER) is the interest rate for a savings account or investment product that has more than one compounding period.
Borrowers can benefit if a loan is set up using variable rates, and the prime interest rate declines (usually in tougher economic times. The result is the annual percentage rate.Even though Main Street Americans don't usually get the prime interest rate deal when they borrow for a mortgage loan, auto loan, or personal loan, the rates banks do charge for those loans are tied to the prime rate.The discount rate is usually walled off from the general public - it's the interest rate the Banks lean on the discount rate to cover daily funding shortages, to correct liquidity issues, or in a genuine crisis, keep a bank from failing.The term simple interest is a rate banks commonly use to calculate the interest rate they charge borrowers (compound interest is the other common form of interest rate calculation used by lenders.
Lenders include that interest amount to the loan balance, and use that amount in calculating the next year's interest payments on a loan, or what accountants call "interest on the interest" of a loan or credit account balance.Use this calculus to determine the compound interest going forward:The key difference between simple interest and compound interest is time.Let's say you invested $10,000 at 4% interest in a bank money market account. Here's the calculus banks use when determining simple interest:For example, let's say you deposited $5,000 into a money market account that paid a 1.5% for three years. But after that, the rate of interest earned rises on a year-to-year basis.For example, using the same $10,000 invested at a 4% return rate, you earn $400 the first year, giving you a total account value of $10,400. Nominal value of a security, often referred to as face or par value, is its redemption price and is normally stated on the front of that security.What Does Nominal Mean and How Does it Compare to Real Rates
A fixed interest rate is as exactly as it sounds - a specific, fixed interest tied to a loan … Total interest going forward for the second year isn't based on the original $10,000, now it's based on the total value of the account - or $10,400.Each year, the 4% interest kicks in on the added principal and grows on a compound basis, year after year after year. )Like APR, the calculation for simple interest is basic in structure.
)That said, if base interest rates rise, then the variable rate loan borrower may be forced to pay more interest, as loan interest rates rise when they're tied to the prime interest rate.Banks do this to protect themselves from interest rates getting too out of whack, to the point where the borrower may be paying less than the market value for interest on a loan or credit.Conversely, borrowers gain an advantage, too. The nominal interest rate is the interest rate before taking inflation into account, in contrast to real interest rates and effective interest rates.
Nominal is a common financial term with several different contexts, referring to something small, an unadjusted rate, or the face value of an asset.
For example, a loan with frequent compounding periods will be more expensive than one that compounds annually, which is a vital consideration when shopping for mortgages.
Interest is …
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