Question

Suppose you buy a house in 2016 and finance it with a 30-year mortgage that has a 6 percent annual rate of interest. Inflation during 2017 is 4 percent. What is the real rate of interest you pay on your mortgage in 2017?

Answer 1

The real interest rate on the mortgage for 2017 is calculated by subtracting the inflation rate from the nominal interest rate, which results in a real interest rate of 2%. This represents the true cost of borrowing once inflation's reduction of money's purchasing power is considered.

Step-by-step explanation:

To determine the real rate of interest on a mortgage after considering inflation, we subtract the rate of inflation from the nominal interest rate of the mortgage. Given that the nominal interest rate on the mortgage is 6% in 2016 and the inflation rate for 2017 is 4%, we calculate the real interest rate for 2017 as follows:

Real interest rate = Nominal interest rate - Inflation rate

Real interest rate = 6% - 4% = 2%

So, the real rate of interest paid on the mortgage for the year 2017 is 2%. This means, effectively, the purchasing power of the money used to pay the mortgage has only reduced by 2%, taking into account the inflation.

Note: This example uses a fixed-rate mortgage to illustrate the impact of inflation, unlike an adjustable-rate mortgage where the rate would change with market rates over the life of the mortgage.

2017, with a nominal interest rate of 6% and an inflation rate of 4%, the real interest rate on the mortgage is 2%. This real interest rate reflects the actual cost of borrowing money, once inflation is taken into account.