The prime rate, or prime-lending rate, is the lowest rate of interest banks and lending institutions charge their best borrowers because they are considered a lower risk for defaulting. Usually these borrowers are large businesses and are seeking an unsecured short-term loan. The prime rate is a widely used tool in determining low rates on credit cards and lines of credit for homes. It is based on rates set by the Federal Reserve.
The prime rate is frequently used to determine interest rates on other kinds of loans. Because it can vary with fluctuations in the economy, it can be an indicator of those changes. The prime rate and long-term mortgage rates are not the same, but the prime rate can affect long-term rates. It is also different from consumer loans and personal property loans that are usually higher.
The prime rate can be used to set rates for adjustable rate mortgages (ARM) and other variable rate loans. These kinds of loan rates are calculated as a percentage amount higher or lower than the prime rate.
Most lenders’ prime rate is set at 3 percent above the rate set by the federal government. The Federal Open Market Committee (FOMC) sets the government rate. This Committee meets about every six weeks to set the federal funds rate. When this rate changes, the prime rate usually follows. Some rate indexes, such as the Wall Street Journal Prime Rate, doesn’t change every time the Federal rate changes. The WSJPR changes when lenders need a rate change to match the rate at which their customers borrow.
Historically, the prime rate was the same among banking institutions. Today, banks are usually within a quarter, half or one percent of each other. Recent troubles in the loan and investment world have changed things drastically and will take some time for the dust to settle. To keep track of the prime rate changes by the FOMC during these uncertain times, refer to the index maintained by the Wall Street Journal.