Processes by which children interpret homonyms were examined. Participants were 16 two-and three-year-olds, 32 four-year-olds, 32 seven-year-olds and 32 ten-year-olds. Each child individually was asked to interpret keywords from stories read aloud by an examiner. Keywords were homonyms, nonsense words, or unambiguous words. For the three older groups, response times (RTs) to unambiguous words were significantly shorter than RTs to homonyms and nonsense words, when interpretations for all three-word types were consistent with the story contexts. Seven-year-olds had longer RTs for homonyms versus nonsense words. RTs did not vary among responses to homonyms. Four-and seven-year-olds had longer RTs for inappropriate, versus appropriate, nonsense-word interpretations. The number of cues recalled from a story about a keyword did not differ across appropriately versus inappropriately interpreted homonyms, but did differ across appropriately versus inappropriately interpreted nonsense words. These findings have implications for understanding how children arrive at literal interpretations of homonyms.