Real Interest Rate Calculator

The real interest rate is the interest rate from which inflation effects are subtracted. It shows how the actual purchasing power behind a loan or deposit has changed and should not be judged only by the numbers shown on the screen. This calculator uses the Fisher equation to determine the real interest rate. It can also be calculated backwards: if two of three values (nominal interest rate, inflation rate, and real interest rate) are entered, the third value will be calculated.

What is an effective interest rate?

The nominal interest rate is the stated interest rate. These are the rates banks offer on savings accounts or charge for loans. Inflation is the rate at which prices rise and measures the loss of purchasing power of money over a given period of time.

The real interest rate is the nominal interest rate adjusted for loss of purchasing power due to inflation. It shows the actual increase in purchasing power that a lender receives after taking into account inflation, and also represents the actual cost to a borrower. A high real interest rate means higher returns on savings but also more expensive loans. A low or negative real interest rate leads to lower returns on savings accounts and makes borrowing cheaper in real terms.

Fisher's equation

The Fischer equation describes the exact relationship between these three types of interest rates. It is named after American economist Irving Fisher. The nominal rate and inflation rate are both expressed as decimals to calculate the real interest rate.

In this formula "r" is the real interest rate, "i" is the nominal interest rate and π is the Greek letter for inflation. Suppose you take out a loan with a nominal interest rate of 5 percent and expect an annual inflation rate of 2 percent. The exact real interest rate would be:

Approximation and when approximation does not apply

At low interest rates, the Fisher equation approximates a simple subtraction, which gives an approximate value for the real rate of interest.

In the above example, the simple calculation gives 3 percent because it subtracts 2 percent from 5 percent while the accurate value is 2.94 percent. At low rates both values are very similar but as interest rates rise the difference becomes larger. This is because the simple calculation ignores that inflation also devalues the interest earnings themselves. When the inflation rate is high this difference will be large enough to affect the result. So this tool shows two values at once: one calculated with the simple formula and the other the accurate value, as well as the difference between them.

Negative real interest rates and deflation

If the inflation rate exceeds the nominal interest rate, then the real interest rate becomes negative. During the term of a loan, less can be purchased with the money repaid than was originally borrowed, resulting in a loss of purchasing power for the lender. The opposite is deflation, when prices fall and the inflation rate becomes negative. In this case, the real interest rate exceeds the nominal interest rate, and each dollar repaid is worth more than it was at the beginning of the term.

Expectations and reality: before and after

Because the inflation rate cannot be known in advance with certainty, economists divide nominal interest rates into two categories. The expected real interest rate (ex ante) uses the predicted inflation rate and serves as a basis for planning by borrowers and lenders. The actual real interest rate (ex post) uses the realized inflation rate and is only known after the fact. If the rate of price increases exceeds expectations, then the actual realized real interest rate will be lower than the planned value, which benefits borrowers but hurts lenders. Entering the expected inflation rate allows you to make informed decisions for the future, while entering the actual inflation rate allows you to check the actual return on past loans.

Here's how to use this calculator:

Enter two of the three rates and leave the rate you want to calculate blank. The calculator will fill in that value and show a simple approximation next to it. Additionally, there are two optional more detailed levels. If you open the "Buying Power" level, the interest rates are expressed in dollars so you can see the nominal rate, the actual gain taking into account current money's worth, and the loss due to inflation. If you open the "After Tax" level, the nominal rate is first taxed and then adjusted for inflation. This is the return that a taxable saver actually keeps.

The table below shows the input fields and examples for each entry.

Areas of application for effective interest rates.

Savers use it to judge whether their deposits are actually increasing in value or merely keeping pace with inflation. Borrowers use it to compare the true cost of mortgages and car loans. Investors use it to compare the effective yields on bonds and decide where they can best put their money to preserve its value. Central banks watch the effective rate closely, because it is real interest rates - not nominal ones - that affect overall spending, saving and investment.

Tips for a meaningful estimate:

Adjust the inflation data to match the time period. For short-term loans you should use last year's inflation rate, while long-term mortgages require a longer average. At high interest rates or large amounts, prefer the results of the exact Fisher equation over simple calculations. Remember that taxes are levied on nominal interest and not actual gain, so savers in higher tax brackets can end up with negative real return after taxes despite positive real interest rate.