Prime Rate: What It Is and How It Works

Whether you’re looking at your credit card, applying for a loan, or watching the news, you’ve probably heard the term “prime rate.” Prime is a common financial term that affects many of us from how much interest we pay on a loan to the interest rate of a new credit card.

So, what is “prime rate”?

Prime rate is also referred to as “prime lending rate,” “prime interest rate,” or just “prime.” The prime rate is the interest rate banks charge each other, corporations, or large institutions for loans. 

In the US, the prime rate is affected by the Federal Reserve lending rate to banks. Historically, prime is set about 3% above the Federal rate. But the prime rate can rise and fall depending on the Federal rate and other economic factors.

What is the current prime rate?

Prime rates change all the time. To see the current rate, check out this prime rate chart that shows both current and past rates.

How do banks use the prime rate?

Banks use the prime rate to set some consumer rates, like adjustable-rate mortgages (ARM) or annual percentage rates (APR) for credit cards.

For example, let’s say the Federal reserve rate is set at 1%. Bank A loans money to Bank B for 4% (since the prime rate is 3% higher than the 1% Federal reserve rate). Bank A and Bank B will both use the 4% prime rate as the figure to calculate ARMs, APRs, or other variable-rate loans.

How does the prime rate affect a home mortgage?

The average, everyday consumer won’t have access to a variable-rate loan set at the prime rate. The prime rate is generally only given to large entities, like corporations and banks. But there is a trickle-down effect with prime rates and its impact on consumers. 

A change in the prime rate could cause a change in your monthly loan payments if you have a variable-rate loan, such as:

  • An adjustable-rate mortgage
  • A HELOC (home equity line of credit)
  • A bridge loan
  • A property refinancing loan

If your home mortgage has a fixed interest rate, then a change in the prime rate won’t have a direct effect on your current mortgage. 

But if you decide to refinance, that is when you’ll see a change in the interest rate. This is why many people choose to refinance when the prime rate is low hoping to secure a lower interest rate on their current mortgage.

Is prime rate the only factor used to determine an interest rate?

The prime interest rate is the starting point for many lending institutions, but it’s not the only factor they take into consideration. When putting together a home mortgage or other loan, banks will look at your credit score, credit history, and the general state of your current finances.

If you have questions, let us know and we’ll direct you to the right resources!

 Your Team at Liberty Title Company of America

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