Start talking about money and interest rates come into the equation. Get a mortgage, buy a house, or get an auto loan—you will hear about interest rates. But what you may not know is that the interest rate referenced most of the time is the nominal interest rate, and not the real interest rate. So what is the difference between real versus nominal interest rates?
If you want to purchase something now but do not have the cash to spend, what you can do is to borrow it. This borrowing does have a cost though, it is called interest. It is an amount that you have to pay on top of the money you have loaned– the principal amount. The rate of interest is often expressed as an annual percentage of the principal. To illustrate, if you have borrowed $1,000 with an interest rate of 10 percent per year payable after a year, you will pay a total amount of $1100 at the end of the year. Loans can be short term or long term, hence the borrower is said to pay either short term interest rates or long term interest rates.