Financial Fact: What is the Prime Rate and Its Impact

What is the Prime Rate?

Most of us have been paying attention this year as the Federal Reserve Bank (Fed) has raised the interest rate four times for a total of 2.25 percentage points.  Raising the interest rate is one of the primary steps the Fed is taking to lower inflation.  The rate set by the Fed, also known as the federal funds target rate, is the interest rate that banks use to borrow and lend from one another overnight, and it serves as the basis for what becomes the prime rate.

The prime rate is the interest rate which financial institutions like banks and credit unions will use to lend money to their most creditworthy customers.  This rate is generally only extended to large institutional and corporate investors.  Typically, banks will add 3 points to the current fed funds target rate to determine the prime rate.  

“As of Nov. 3, 2022, the current prime rate is 7% in the U.S., according to The Wall Street Journal’s Money Rates table, which lists the most common prime rates charged throughout the U.S. and in other countries by averaging out the prime rate from the 10 largest banks in each country.”¹  The federal funds rate is currently 3.75% to 4% and adding 3% to the 4% federal funds target rate gives us the current 7% prime rate  The prime rate only changes when there is a change in the federal funds target rate.

How the Prime Rate Impacts You

The prime rate serves as the baseline that financial institutions use to set lending rates for mortgages, loans to small businesses and personal loans to consumers.  Since the prime rate is directly connected to lending, it is sometimes called the prime lending rate.  Understanding the impact of the prime rate can provide a window into what interest rate borrowers can be expected to pay.  When the prime rate increases:

• Interest rates for personal loans, car loans, small business loans, lines of credit and credit card rates will increase.
• The bank associated with any debt you are carrying that is tied to a variable rate can change your rate. Interest rate hikes can affect variable-rate mortgages or home equity loans and variable-rate student loans, credit card and personal loans.  This means your monthly payment will be higher.

While the prime rate serves as an important factor in the interest rate that will be extended to you when you borrow money, it is not the only factor.  Your rate will be decided by the financial lender and can be higher than the prime rate.  For example, the rate you pay when you apply for a credit card will also be influenced by your credit history and your credit score.

Keep in mind that when the prime rate increases or decreases, consumer borrowing rates generally follow suit. Depending on your financial goals, by keeping an eye on the prime rate, you can gauge the most favorable periods to take out a personal loan, line of credit or negotiate advantageous mortgage rates.

1. https://www.forbes.com/advisor/investing/prime-rate/

The information contained herein is for informational purposes only.  While MMBB made every attempt to ensure that the information is accurate, MMBB is not responsible for any errors or omissions or the results obtained from the use of this information.  MMBB is not liable for any success or failure that is directly or indirectly related to the use of the information contained herein.  The information contained herein does not constitute any financial, insurance, investment, legal, or tax advice.  In no event shall, MMBB and/or its fiduciaries, directors, officers, employees, or agents thereof be liable for any special, direct, indirect, consequential, or incidental damages or any damages whatsoever, whether in action of contract, negligence or tort, arising out of or in connection with the use of the information contained herein.