Meaning of the nominal interest rate

The nominal interest rate is part of the loan conditions. It is often also referred to as the Sollzins and appears in all types of loans. For loan interest, a basic distinction is made between the nominal interest rate and the effective interest rate. Both affect the cost of financing differently and therefore must be taken into account when calculating individual interest rates.

The nominal interest rate does not take any costs into account. These are only reflected in the effective interest rate. In principle, the nominal interest rate can be found for both loans and investments. For investments it indicates the return offered by the provider. If fees are charged for these investments, they must be deducted as a percentage from the nominal interest rate in order to calculate the actual return.

By contrast, they must be added for loans in order to determine the effective interest rate. In the investment sector a nominal interest rate can fundamentally not be lower than the effective interest rate. A different picture emerges, however, in the loan sector. Here the nominal interest rate is lower in the majority of cases. For loans the effective interest rate is higher than the nominal interest rate because costs in the form of fees arise with every loan or repayment is not calculated on a day-by-day basis.

Differences between nominal interest rate and Sollzins

Lenders now often use the term Sollzins for loans. Since the implementation of the new Consumer Credit Directive, which took place on June 11, 2010, Sollzins has been the new term for the nominal interest rate. It fundamentally indicates the level of the respective loan interest. For example, if the nominal interest rate is three percent and a loan amount of 100,000 euros is taken out, annual interest costs of 3,000 euros will arise.

The effective interest rate, which is ultimately decisive for the borrower when calculating the financial burden, is above the level of the nominal interest rate. It takes all other cost factors into account. Therefore, when reviewing loan offers, it must be checked whether the provider quotes the nominal interest rate or the effective interest rate.

The nominal interest rate always relates to the face value of the investment or the loan. It is also referred to as the nominal value. The percentage therefore always refers to the nominal amount in the case of loans. The calculation method is different for a bond. For a bond, the nominal interest rate determines the interest payment that the issuer has to make. This is also known as the coupon.

The nominal interest rate does not take into account any possible processing fees nor a discount (disagio). The interest is always expressed as a percentage. Rates of price increases are not taken into account in the nominal interest rate. This is what distinguishes it from the real interest rate. The nominal interest rate differs significantly from the yield. This figure is aimed at the bond price or the respective disbursement amount of a financing. Different financial-mathematical calculation rules are used to calculate yield and the effective interest rate. A distinction must be made between price calculation and repayment calculation.

Agreement on the nominal interest rate

When taking out a loan, the nominal interest rate is agreed individually with the bank. In principle it can be designed to be dependent on creditworthiness. Accordingly, the borrower's creditworthiness affects the level of the nominal interest rate to a certain extent. The resulting interest is paid together with the monthly installments in the case of installment loans. They include any fees or costs incurred in connection with a concluded residual debt insurance.

Roughly speaking, the monthly installments consist of the repayment portion and the interest. The nominal interest rate serves as the basis for calculating the effective interest rate when taking out a loan. The latter is affected by residual debt insurances as a cost factor if they are taken out at the borrower's request. Through prepayments the costs defined by the nominal interest rate can be reduced. It always refers to the loan amount as a percentage.

By making prepayments, consumers reduce the amount of the loan to be repaid and thus also the interest burden. Individual conditions of the lender must be taken into account for prepayments. They are not always permitted without restriction. Some lenders charge additional fees for extensive annual prepayments, which are then levied in connection with the nominal interest rate.

Fixed or variable nominal interest rate

Between borrower and lender, the nominal interest rate can be defined as either a fixed or a variable rate. If the nominal interest rate is fixed, it is included in the loan contract for the entire term. This means there are neither reductions nor increases in the interest rate. The borrower therefore has planning security throughout the entire term.

With a variable nominal interest rate, changes are possible. It must be distinguished whether the nominal interest rate is variable from the outset or is initially fixed for a certain period. For loans with long terms, a variable nominal interest rate is usually used, which is then adjusted after a certain time window. This time window can be agreed individually between lender and borrower.

In principle, there is also the possibility that the nominal interest rate is linked to the development of a reference rate. Accordingly, it is adjusted continuously. In this case the loan agreement contains a so-called interest adjustment clause. If the reference rate rises, the nominal interest rate also rises. Variable nominal interest rates have become established particularly for longer terms in the past.

A loan for which the nominal interest rate is generally always variable is mortgage financing. After an agreed time window, the variable nominal interest rate is adjusted to the reference rate. For many loans this happens after a period of ten to 15 years. The new nominal interest rate reflects both developments in the reference rate and adjustments to fees. In principle, loan fees charged by banks can also change. However, every nominal interest rate is negotiable and must be agreed individually with the lender.

Costs of a loan

Costs that arise with a loan occur for various reasons. In addition to fees for documents, for example a Schufa report causes financial burdens that are passed on to the borrower. The effective interest rate therefore always consists on the one hand of the nominal interest rate and on the other hand of all incurred costs. For comparisons the nominal interest rate is an important figure. Since it flows into the effective interest rate, it is decisive for the interest that arises.

During a loan comparison the nominal interest rate alone is not sufficient, because there can be large differences in fees. The nominal interest rate should not only be included in loan comparisons, but should also be taken into account for investments. In that context it is a decisive criterion when choosing investments.