What Is The Prime Rate? – Forbes Advisor

Editorial Note: We earn a commission from partner links on Forbes Advisor. Commissions do not affect our editors’ opinions or evaluations.

The prime rate is one of the main factors banks use to determine interest rates on loans. If you’re in the market for a new variable rate mortgage or a personal loan, understanding the prime rate and how it works can give you a better grasp on how much you’ll pay and the best time to get a loan.

Prime Rate Definition

The prime rate is the interest rate banks charge their best customers for loans.

“Best in this sense are the borrowers with the least risk of default,” says Jeanette Garretty, Chief Economist & Managing Director at Robertson Stephens, a wealth management firm in San Francisco. It’s usually the lowest interest rate banks will charge and is a benchmark to determine interest rates for other products, like lines of credit, credit cards and small business loans.

But the prime rate is only one factor among several that determines how much you’ll pay for loans. Banks also take into account your creditworthiness—the more likely you are to pay them back, the lower the rate they would charge and vice versa.

Compare Personal Loan Rates From Top Lenders

Compare personal loan rates in 2 minutes with Credible.com

Who Gets the Prime Rate?

Banks usually only charge the prime rate to large, corporate customers with lots of financial resources. That’s because they have more money and assets to pay the loans back. Since individual consumers do not have the same resources, banks typically charge them the prime rate plus a surcharge based on the product type they want. A credit card rate might be the prime rate plus 10%, for instance.

On the other end of the spectrum, a bank’s very best borrowers may be able to negotiate lower than the prime interest rate. This kind of negotiation happened more frequently in the 1980s, Garretty notes, when interest rates were much higher. Lenders would try to attract “blue chip” borrowers by offering interest rates lower than the prime rates.

How Does the Federal Funds Rate Impact the Prime Rate?

The federal funds rate is an interest range set by the Federal Reserve. The fed funds rate is the Fed’s recommendation for what banks should charge when they lend money to each other overnight to meet reserve requirements.

“There is a rule of thumb that the prime rate is “fed funds plus 3,” says Garretty. “When the Fed funds rate changes, one bank will usually take the lead and announce a change in that bank’s prime rate that same day.”

The prime rate moves only when the federal funds rate moves. “This is other rates (LIBOR, treasuries), which move daily/weekly according to short term financial market (supply and demand) conditions,” says Garretty.

Once a bank changes its prime rate based on the new federal funds rate, it will then start adjusting rates for many of its other lending products in the same direction. And when the federal funds rate and prime rate go down, other rates fall too, making it less expensive to borrow.

Note that certain lending products, like fixed rate mortgages and some student loans, are based on measures like SOFR and are less tied to the movement of the prime rate.

What Is the Current Prime Rate?

As of Feb. 8, 2022, the current prime rate is 3.25% in the US, according to The Wall Street Journal’s Money Rates table, which lists the most common prime rates charged throughout the US and in other countries by averaging out the prime rate from the 10 largest banks in each country.

The federal funds rate is currently 0.00% to 0.25%, so with that in mind, you can see how the “fed funds plus 3” rule of thumb plays out: 3 + 0.25% = 3.25%.

Each bank has the ability to set its own prime rate. Most base it off the national average listed under the WSJ prime rate, but some could charge more or less depending on their goals.

Prime Rate History

To give you an idea of ​​how the prime rate moves and how often, here’s a look at changes to the prime rate in recent years:

The 10 Most Recent Prime Rate Changes

As you can see from the table, plus the longer-term chart below, the prime rate today is at historic lows. It can’t drop any further because the fed funds rate is the lowest it can be without going negative.

“The last time rates were this low during the financial crisis, when prime rates were also 3.25% starting in December of 2008,” says Daniel Milan, managing partner of Cornerstone Financial Services in Southfield, Mich.

“Rates began to rise in 2015 or so and continued to rise until March of 2020 due to Covid-19. If you go back further into history, you never saw rates these low as you would often see them in the mid-high single digits or even the low double digits especially in the ’80s and ’90s,” he says.

How Does the Prime Rate Impact You?

The prime rate sets the baseline for a variety of bank loans. When the prime rate goes up, so does the cost to access small business loans, lines of credit, car loans, certain mortgages and credit card interest rates. Since the current prime rate is at a historic low, it costs less to borrow than in the past.

The prime rate is also important if you have any debt with a variable interest rate, where the bank can change your rate. This includes credit cards as well as variable rate mortgages, home equity loans, personal loans and variable rate student loans. If the prime rate goes up, the bank could end up charging you a higher interest rate so your monthly payment on variable debt would increase.

“Decisions by a bank’s asset and liability committee will ultimately determine where those other rates will settle,” says Garretty. They might also take into account their business strategies. For example, if one bank wants more credit card business on their books while another does not, they will quote different credit card rates, even though they are working off the same prime rate.

That’s why seeing the impact of a prime rate hike might not be immediately obvious. However, over time, the prime rate does push consumer rates in the same direction. By keeping an eye on the prime rate trends, you can get a sense of how expensive it will be to borrow and you can plan around any changes.

Leave a Comment

Businesswebsiteindex