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Nominal vs. Annual Percentage Rate: What’s the Difference?

March 30, 2015

After posting an article about teaser rate mortgages here, we’ve received a lot of questions from prospective buyers looking to get a better understanding the different mortgage rates being offered in the Canadian mortgage market. When taking out a mortgage, it is important to be able to read and comprehend the meaning behind the interest rate terms in your contract. Essentially, there are two different types of interest rates commonly used; however, each of them is sometimes known by more than one name.

– Nominal Interest Rate. Also known as simple interest rate. Nominal interest is calculated on the original principal balance only. If you borrow $100,000 for one year at 5%, you end up paying back $105,000.

– Effective Interest Rate. Also known as compound interest. With effective interest, the interest rate is applied to the original principal AND all the accumulated interest. If you borrow $100,000 for one year at 5% and the interest is compounded monthly, you end up paying back $105,062.50. Therefore, the effective interest rate is actually 5.0625%. In Canada, this is known as the Annual Percentage Rate (APR) and it’s the rate that Canadian mortgage lenders are required to quote.

Of course, actual mortgages are more complicated than this because payments are made monthly (or even more frequently), rather than at the end of the year. But the result is still the same: the effective interest rate is slightly higher than the nominal interest rate. If you have any questions about the interest rate on your mortgage or any other mortgage related questions, don’t hesitate to reach out to us at 416-480-0234 or send us an email at Info@MonsterMortgage.ca

As always, thanks for reading!