A prime rate gives an individual or corporation the best interest rate possible based on their credit history and relationship with the bank.
A bank will offer its customers an interest rate based on their default risk. A default risk is the possibility that the customer will not be able to adhere to the payment specifications of the terms that their loan was based on. Because well qualified clients are regarded as having a low chance of defaulting, they are rewarded with the prime rate. Some banks even offer well qualified customers rates unadvertised rates below the prime rate.
The federal funds target rate determines the Prime rate and is based on the rate that banks bill one another for loans, which allows them to meet their Federal Reserve stipulations at the end of each night. Generally, the principle rule is that the prime rate is three percent more expensive . Most major credit card companies establish their fixed interest rates on these fluctuating prime rates, and tack on a supplemental value.
The Prime Rate is historically known to fluctuate, but as of the past few years it has been reasonably stable. In the late 80’s and early 90’s, the Prime Rate was as high as 10-11%, which seems high by todays 5% rate, and in 1980 it was as high as 21.50%, which was a U.S. Prime rate record. Since 2008, the prime rate has leveled off and now hovers between 4-5%. The reason the prime rate fluctuates, is because it mirrors the federal funds rate set by the Federal Open Market Committee (FMOC) of the Federal Reserve Board.
How This Affects You:
If you are looking to take out a loan for a car or a mortgage or any consumer debt, it is imperative to keep an eye on the prime rate, as it affects the rates that lenders offer their clients.
If you carry credit card debit, student loans, and adjustable rate mortgage or any consumer debt with an outstanding balance, then you could experience a fluctuation in the prime rate, which could affect the interest rate on your balance or debt. This debt balance can then be compounded by an increase in the interest rate, which in turn can cause an increase in the minimum payments due and can also cause the outstanding balance to grow.
Understanding the prime rate not only allows for qualified businesses and individuals to be able to obtain the best interest rate available, but also allows for others who don’t meet the criteria for a prime rate to understand how this universal number can still affect their finances.
