The prime rate is a key interest rate that influences most other rates. Here’s how it moves, and why it affects what your loans and credit cards cost

Prime interest rate

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The prime rate, aka the prime lending rate or simply the prime, is the interest rate that banks charge their biggest, most creditworthy corporate customers, along with very high net worth individuals. Think blue-chip stock companies or the likes of Warren Buffett. 

But while the prime does not directly affect most consumers, it does provide the benchmark for many consumer and small business loans. It also affects other types of everyday debt, like credit cards, mortgages, and home equity lines of credit.

What is the Prime Rate?

The prime rate is an interest rate charged on loans. Much like any other interest rate, the prime exists to cover costs and losses associated with financing. It acts as the compensation for the multiple risks banks expose themselves to when extending credit to clients. 

Only stable businesses with the highest credit ratings qualify for this prime interest rate, as they are the ones that pose the least risk of defaulting on their loans. As the name “prime” implies, it tends to be the best — that is, the lowest — interest rate the financial institution charges.

Although it’s a variable, or floating, interest rate, the prime does not change at regular intervals. Rather, banks adjust it according to the shifts in the economy and the business cycle. The prime may not change for years.  Or it can potentially change several times within one year especially in economically turbulent times.

Who determines the prime rate?

The prime rate is not set by the government. But it does closely follow another interest rate, which is set by the Federal Reserve: the federal funds rate. 

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The Fed sets and adjusts the federal funds rate to keep the US economy on an even keel between recession and over-expansion.  When the economy slows down, the rate is lowered to spur economic growth. When the economy grows too fast, the rate gets raised to try and stave off inflation.

Commercial banks use the federal funds rate when charging each other for overnight loans. In turn, these banks use the same rate as the starting point in setting the prime rate for their best-qualified clients.

Commercial banks generally adjust the prime rate roughly three percentage points above the federal funds rate. However, some banks set their lending rates up to five percentage points higher.



What is The Wall Street Journal Prime Rate?

There actually is no single prime rate; each bank or financial institution sets its own, based on its own lending criteria. When you see a reference to “the prime rate,” it usually reflects an average rate across financial institutions.

 The most commonly cited average — the “official source,” so to speak — comes from The Wall Street Journal, which regularly surveys 30 of the largest US banks and publishes a consensus prime based on their rates.  The Journal reports this average prime rate daily, whether there are changes to it or not. It alters when three-quarters of these financial institutions adjust their rates. 

What is the prime rate today?

As of this writing, the …read more

Source:: Businessinsider – Finance


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