What is the Prime Rate?

Friday, May 29th, 2009

What is the Prime Rate?

Prime Rate Information

Some banking consumersĀ are aware of the term “Prime Rate,” but don’t understand its definition, except as a measurement or index from which other interest rates are compared. Actually, this understanding is important and gives potential borrowers good clues on how interest rates on autos, equity, and personal loans are trending.

Typically, when the prime rate goes down, other loan rates tend to decrease. Conversely, as the prime rate increases, consumer loan rates follow.

The prime rate, however, is really the elusive annual percentage rate that is offered to the best commercial loan borrowers. Prime rate is actually not the bedrock of all interest rates, contrary to some general perceptions. The “discount rate,” as set by the Federal Reserve, is “prime” index rate that tends to drive all others, from savings to loans.

The prime rate will be a bit higher than the Federal discount rate and many lenders will price their other loans using some percentage above prime. Lenders make this calculation, in concert with their competition, for most types of consumer loans.

Lenders wanting to increase their loan portfolio will typically price loans lower than their competition, while higher interest rates will apply if they don’t need new loan volume. Consumers seeking equity loans can often find deals that offer prime rate or close to prime rate interest “specials.”

In most cases, however, those borrowers offered loans at the prime rate will be large commercial entities with excellent credit ratings. Although the prime rate is set by financial institutions individually, its use as an “index” of other rates tends to encourage all lenders to set the same annual percentage rate for clarity more than income reasons.

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