Any significant financial operations, including investing, borrowing, or lending, must take into account the change in the real value of money due to such factors as inflation or deflation. Since they affect the purchasing power of money, the same funds at the time of the financial deal and by the time dividends are received or, conversely, borrowed money are returned may have a different value. That is why to calculate your potential benefit, you need to take into account the real interest rate.
Why Relying on the Nominal Interest Rate Isn’t Enough?
The interest rate is the price that a person receives for using their money when lending or, conversely, pays for using the lender’s money in the case of borrowing. When you read the ads of different financial institutions, which indicate the interest rate on loans or the return on deposit, they reflect the nominal interest rate without inflation.
However, situations of stability can be disturbed by various cataclysms, including natural disasters, economic downturns, wars, etc., as a result of which inflationary processes and the depreciation of money may begin. This situation affects deposits and loans in different ways:
- With a high level of inflation, the interest received on a deposit may turn out to be quite insignificant and not even cover the inflation rate.
- If you took a loan at a fixed rate, you will return less money in real value, given their depreciation.
Therefore, to predict whether you will win or lose in a financial operation, it is important to take into account inflation or the real interest rate.
Is It Easy to Determine the Real Interest Rate?
Theoretically, the real interest rate is very easy to calculate. To do this, it is enough to subtract the inflation rate from the nominal interest rate. Don’t be surprised if this figure turns out to be negative. Because if, for example, the nominal rate is 6%, and the inflation rate is 9%, in the end, the real interest rate will be equal to -3%.
In reality, it is quite difficult to calculate this indicator if you are making a forecast for your investments or taking money on credit. Because for this, you need to know the future inflation rate, but knowledge about the future can only be probabilistic. And if you search for what the inflation rate might be in a year, you will find many analytical forecasts with different numbers. Therefore, even choosing the number that seems most convincing to you, it will only be probabilistic knowledge.
How to Compare Interest Rates on Loans
When evaluating the true cost of your loan, consider the many additional factors that are included in the repayment amount, such as:
- Additional commissions
- Service charge
- Issuance of a credit card, etc.
So that you can compare all these and other loan conditions, use the services of the Payday Depot platform, which allows you to make the best choice among many offers from different lenders.
When you’ll take out a loan or put money on deposit, be sure to ask how inflation is taken into account. And if the inflation policy of a bank or lender doesn’t suit you, look for options with a fixed interest rate.