Types of Interest Rates
There are six main categories of interest rates, organized by their application and characteristics: Nominal Interest Rate, Real Interest Rate, Effective Interest Rate, Flat Interest Rate, Fixed Interest Rate, and Floating Interest Rate.
Main Categories
- Nominal Interest Rate — the rate charged on a loan or credit product without considering inflation, as seen in the 4% nominal interest rate on a Wells Fargo credit card.
- Real Interest Rate — the rate of return on an investment or loan after adjusting for inflation, such as the 2% real interest rate on a US Treasury bond.
- Effective Interest Rate — the rate that reflects the effects of compounding interest, as in the 6% effective interest rate on a Bank of America savings account.
- Flat Interest Rate — a fixed interest rate charged on a loan, regardless of the loan's outstanding balance, as with the 5% flat interest rate on a Ford Motor Credit auto loan.
- Fixed Interest Rate — an interest rate that remains constant over the life of a loan, exemplified by the 3.5% fixed interest rate on a Fannie Mae mortgage.
- Floating Interest Rate — an interest rate that fluctuates based on market conditions, as with the Libor-based floating interest rate on a JPMorgan Chase commercial loan.
Comparison Table
| Category | Cost | Scale | Speed |
|---|---|---|---|
| Nominal Interest Rate | Lower | Large | Fast |
| Real Interest Rate | Higher | Small | Slow |
| Effective Interest Rate | Medium | Medium | Medium |
| Flat Interest Rate | Higher | Small | Fast |
| Fixed Interest Rate | Lower | Large | Slow |
| Floating Interest Rate | Medium | Medium | Fast |
How They Relate
The Nominal Interest Rate and Real Interest Rate are related in that the real interest rate is calculated by subtracting the inflation rate from the nominal interest rate, as described in Fisher's equation of exchange. The Fixed Interest Rate and Floating Interest Rate are often compared when considering loan options, with fixed rates providing stability and floating rates offering flexibility. Meanwhile, the Effective Interest Rate and Flat Interest Rate can be confused due to their similar names, but they serve distinct purposes in calculating interest accrual. Specifically, the Effective Interest Rate is used to calculate the interest earned on a savings account, while the Flat Interest Rate is used to calculate the interest charged on a loan. The Nominal Interest Rate and Effective Interest Rate can also be related, as the effective interest rate takes into account the compounding of interest on a nominal interest rate.