Calculate the real interest rate from the nominal interest rate and expected inflation rate by using the fisher equation. Real interest rates account for inflation.
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Real Interest Rate Formula
The following formula is used to calculate the real interest rate.
ir = i – e
- Where ir is the real interest rate
- i is the nominal interest rate
- e is the expected rate of inflation.
Real Interest Rate Definition
A real interest rate is the expected true interest rate of a loan or credit after inflation is taken into account. Since inflation occurs naturally in a healthy economy, you must take it into consideration when determining a real or true interest rate.
How to calculate real interest rate
Let’s look at an example of applying the formula above. Let say you take out a loan with 7% interest. Next, the expected level of inflation is 2%. Now plug those values into the calculator or equation above, and you have an adjusted real rate of 5%. As you can tell, the real interest rate is lower than the nominal interest rate. As a result, this means that the money you borrowed will be worthless at the end of the year, and so you will actually be paying more.
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