Can Effective Rate and Nominal Rate Ever Be the Same?

Effective rates can be the same as nominal rates; however, the effective rate is usually higher. These rates refer to the amount of interest charged to a specific balance, and the nominal rate is the base rate used in calculating the effective rate. Sometimes the nominal rate does match the effective rate due to factors that affect when and how much interest accrues on the balance, and how it is calculated.

Nominal

The nominal interest rate does not apply to previously accrued interest. In other words, the nominal rate is the agreed upon rate applied to a remaining principal balance only. This is why the nominal rate only equals the effective rate when no interest has been previously applied to a balance. For example, a 15 percent nominal annual percentage rate applied to a $100 balance after one monthly billing cycle will have the same $1.25 nominal and effective interest charge due to no previously carried over interest.

Effective

The effective interest rate is a more accurate measurement when interest is compounded. Using the previous example to illustrate, 15 percent nominal APR charged to a carried over balance of $101.25 will be a charge of $1.27 for a total effective interest rate of 15.12 percent. Thus, in the second billing the nominal interest rate will not equal the effective interest rate due to the nominal rate being applied to the new balance with interest included.

Period

Both nominal and effective rate charges are incurred within the total length of a financial agreement, such as credit card debt. This total period is divided into interest accrual or compounding periods. These periods differ from the periodic payment period or time interest can be paid before being included in the following billing cycle. These periods are key in determining equality between the nominal and effective rate depending on if a balance carries over between them and how much of that balance is paid.

Terms

Terms of financial instruments also determine if nominal and effective rates will match. For example, if the grace period on a credit card purchase with an existing balance is 25 days, and payment on that balance is paid after 30 days, the effective and nominal rates will not be the same. Moreover, the two rates will both be zero if payment in full is made within the grade period of that credit card's terms.