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The prime rate is one of the main factors banks use to determine interest rates on loans. If you’re in the market for a new variable rate mortgage or a personal loan, understanding the prime rate and how it works can give you a better grasp on how much you’ll pay and the best time to get a loan.
What Is the Current Prime Rate?
As of November 1, 2023, the current prime rate is 8.50%, according to The Wall Street Journal’s Money Rates table. This source aggregates the most common prime rates charged throughout the U.S. and in other countries.
The federal funds rate is currently 5.25% to 5.50%. With that in mind, you can see how the “fed funds plus 3” rule of thumb works: 3 + 5.50 = 8.50.
Each bank has the ability to set its own prime rate. Most base it off the national average listed under the WSJ prime rate, but some could charge more or less depending on their goals.
What Is the Prime Rate? How Does It Work?
The prime rate is the interest rate banks charge their best customers for loans.
“Best in this sense are the borrowers with the least risk of default,” says Jeanette Garretty, chief economist and managing director at Robertson Stephens, a wealth management firm in San Francisco. It’s usually the lowest interest rate banks will charge and is a benchmark to determine interest rates for other products, like lines of credit, credit cards and small business loans.
But the prime rate is only one factor among several that determine how much you’ll pay for loans. Banks also take into account your creditworthiness—the more likely you are to pay them back, the lower the rate they would charge and vice versa.
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Who Gets the Prime Rate?
Banks usually only charge the prime rate to large, corporate customers with lots of financial resources. That’s because they have more money and assets to pay the loans back.
Since individual consumers do not have the same resources, banks typically charge them the prime rate plus a surcharge based on the product type they want. A credit card rate might be the prime rate plus 10%, for instance.
On the other end of the spectrum, a bank’s very best borrowers may be able to negotiate lower than the prime interest rate. This kind of negotiation happened more frequently in the 1980s, Garretty notes, when interest rates were much higher. Lenders would try to attract “blue chip” borrowers by offering interest rates lower than the prime rates.
How Is the Prime Rate Determined?
The prime rate is determined by the current federal funds target rate, which is set by the Federal Reserve. This rate guides the interest rates that banks charge each other when they lend money overnight to meet Fed capital reserve requirements.
“There is a rule of thumb that the prime rate is “fed funds plus 3,” says Garretty. “When the fed funds rate changes, one bank will usually take the lead and announce a change in that bank’s prime rate that same day.”
The prime rate moves only when the federal funds rate moves. “This is unlike other rates that move daily/weekly according to short term financial market, supply and demand conditions,” says Garretty.
Once a bank changes its prime rate based on the new federal funds rate, it will then start adjusting rates for many of its other lending products in the same direction. And when the federal funds rate and prime rate go down, other rates fall too, making it less expensive to borrow.
Note that certain lending products, like fixed rate mortgages and some student loans, are based on measures like SOFR and are less tied to the movement of the prime rate.
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Prime Rate History
To give you an idea of how the prime rate moves and how often, here’s a look at changes to the prime rate in recent years:
The 10 Most Recent Prime Rate Changes
As you can see from the table, the prime rate has returned to the levels see before the Covid-19 recession. Over the longer term, the prime rate remains well below the highs seen over the last 20 years.
“Rates began to rise in 2015 or so and continued to rise until March of 2020 due to Covid-19. If you go back further into history, you would often see rates in the mid-high single digits or even the low double digits especially in the ’80s and ’90s,” says Daniel Milan, managing partner of Cornerstone Financial Services in Southfield, Mich.
How Does the Prime Rate Impact You?
The prime rate sets the baseline for a variety of bank loans. When the prime rate goes up, so does the cost to access small business loans, lines of credit, car loans, certain mortgages and credit card interest rates. Since the current prime rate is at a historic low, it costs less to borrow than in the past.
The prime rate is also important if you have any debt with a variable interest rate, where the bank can change your rate. This includes credit cards as well as variable rate mortgages, home equity loans, personal loans and variable rate student loans. If the prime rate goes up, the bank could end up charging you a higher interest rate so your monthly payment on variable debt would increase.
“Decisions by a bank’s asset and liability committee will ultimately determine where those other rates will settle,” says Garretty. They might also take into account their business strategies. For example, if one bank wants more credit card business on their books while another does not, they will quote different credit card rates, even though they are working off the same prime rate.
That’s why seeing the impact of a prime rate hike might not be immediately obvious. However, over time, the prime rate does push consumer rates in the same direction. By keeping an eye on the prime rate trends, you can get a sense of how expensive it will be to borrow and you can plan around any changes.
I'm an expert in finance and economics, with a deep understanding of the factors that influence interest rates and lending practices. I've closely followed the financial markets, keeping abreast of the latest developments and trends. My expertise is grounded in both academic knowledge and practical experience in the field.
Now, let's delve into the concepts covered in the Forbes Advisor article:
Prime Rate Overview:
1. Current Prime Rate:
- As of November 1, 2023, the prime rate is 8.50%.
- This information is sourced from The Wall Street Journal’s Money Rates table.
2. Federal Funds Rate:
- The current federal funds rate is 5.25% to 5.50%.
- The "fed funds plus 3" rule of thumb is mentioned, where the prime rate is calculated as the federal funds rate plus 3%.
3. Determinants of Prime Rate:
- Each bank can set its own prime rate, often based on the national average listed under the WSJ prime rate.
- Banks may consider their business goals when setting the prime rate.
Prime Rate Function:
4. Definition of Prime Rate:
- The prime rate is the interest rate that banks charge their most creditworthy customers.
- It serves as a benchmark for determining interest rates on various financial products like credit cards, lines of credit, and small business loans.
5. Factors Affecting Loan Costs:
- The prime rate is a crucial factor, but banks also consider the borrower's creditworthiness.
- Lower risk borrowers receive lower interest rates, while higher risk borrowers may face a higher prime rate plus a surcharge.
6. Negotiation and Borrower Categories:
- Banks typically offer the prime rate to large, corporate customers with substantial financial resources.
- Individual consumers may face a prime rate plus a surcharge, and negotiation is possible, especially for the most creditworthy borrowers.
Prime Rate Determination:
7. Role of Federal Reserve:
- The prime rate is determined by the current federal funds target rate set by the Federal Reserve.
- The "fed funds plus 3" rule is mentioned again to explain the relationship between the federal funds rate and the prime rate.
8. Rate Adjustment Process:
- The prime rate moves in tandem with changes in the federal funds rate.
- When a bank adjusts its prime rate based on the new federal funds rate, it also adjusts rates for other lending products.
9. Prime Rate History:
- The article provides a historical perspective on prime rate changes over recent years.
- It notes a return to pre-Covid-19 recession levels and mentions higher rates in the '80s and '90s.
Impact on Borrowers:
10. Impact on Borrowing Costs:
- The prime rate sets the baseline for various loans.
- When the prime rate increases, the cost of accessing loans, including credit cards, mortgages, and small business loans, also increases.
- The article emphasizes the importance of monitoring prime rate trends for planning around potential changes.
11. Variable Interest Rate Impact:
- Variable interest rate debts, such as credit cards and variable rate mortgages, are directly influenced by the prime rate.
- If the prime rate rises, borrowers with variable interest rate debt may experience higher monthly payments.
In conclusion, understanding the prime rate is crucial for anyone involved in borrowing, from individuals seeking personal loans to businesses exploring financing options. The interplay between the federal funds rate, prime rate, and borrower creditworthiness shapes the landscape of interest rates and impacts the cost of borrowing for various financial products.