Q&A: What is the ‘Prime Rate’ and Why Does it Matter?

Q: What is the prime rate and why does it matter?

A: The prime rate, or prime, is the current interest rate that financial institutions in the U.S. charge their best customers.

We have answered all your questions on the prime rate.

How is the prime rate determined?

First, the Federal Reserve System, which is the central bank of the United States, sets the federal funds target rate, or the interest rate, it thinks is best for financial institutions to use when lending each other money. When financial institutions lend each other money, they base their interest rates on the federal funds target rate. The Wall Street Journal then surveys the country’s largest financial institutions to determine the rate they are using and then publishes it as the prime rate. This number is generally 3 percent higher than the federal funds target rate.

The fed’s target rate, and consequently prime, changes often. The committee who sets the federal funds target rate meets a minimum of eight times a year to discuss possibly changing the rate. You can check out the changes in the prime rate at Federalreserve.gov.

How does the prime rate affect the individual?

Financial institutions and large lenders will base their interest rates on the prime rate, generally establishing their current rates at an amount that is higher than the prime. If the prime rises, the interest rate on loans and adjustable-rate credit cards rises as well.

Second, the prime rate affects liquidity in the financial markets. When the rate is low, liquidity increases. This means funds are more readily available because loans are less expensive and easier to qualify for. This, in turn, generates a growing economy as businesses expand.

Is the prime rate the only factor used to determine individual interest rates?

While the prime is the starting point used to determine an interest rate on a loan, it is by no means the only factor considered.

Your credit score plays a vital role in the interest rate you’ll be granted for a loan. The higher your score, the lower the interest rate you’ll earn. Keep your score high by using your cards sparingly and paying your credit card bills on time.

Here at Scott Credit Union, we also consider the general state of your finances when determining your interest rate on a loan. If we see that you’re working toward paying down your debts, we’ll be more likely to grant you a favorable interest rate.

If you’re ready to apply for a loan, we can help. Scott Credit Union offers competitive rates on loans that help you save on monthly payments throughout the lifetime of your loan.