Any time you hear financial news or see information about loans and mortgages – you may see the term “prime rate” or “prime” used a lot. That’s because the prime rate affects every level of the economy – and nearly every loan, including mortgages and credit cards, is affected by the prime rate.
So what is the prime rate and why does it matter?
The prime rate is the current interest rate that financial institutions in the U.S. charge their best customers. These customers have excellent credit and are eligible for this optimal rate because their loans carry the lowest risk for their financial institutions.
How does the prime rate affect consumers?
The interest rate on nearly every loan, including mortgages and credit cards, is affected by the prime rate.
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 prime to cover their larger risk of default.
In addition, the prime rate affects liquidity or the availability of funds and loans in the financial markets.
What happens when the prime rate is low?
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.
What happens when the prime rate goes up?
If the prime rate rises, the interest rates on your loans and adjustable-rate credit cards will rise as well.
In addition, when the prime rate is high, liquidity is low and loans are harder to come by, slowing the economy down.
How is the prime rate determined?
The prime rate is based on another rate, which is set by the Federal Reserve Board. The prime rate is determined in three steps:
- 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 to maintain their reserve requirements, they base the interest rates they charge each other on the federal funds target rate.
- The Wall Street Journal surveys the largest financial institutions in the country to determine the rate they are using and then publishes this rate as the prime rate. This number is generally 3 percent higher than the federal funds target rate.
How often does the prime rate change?
The fed’s target rate, and consequently the prime rate, changes often. The Federal Open Market Committee, which sets the federal funds target rate, meets a minimum of eight times a year to discuss possibly changing the target rate.
Earlier in September, the Fed lowered the rate – for the first time in four years – by a half percentage point, or 50 basis points.
What else affects interest rates on your loan?
While the prime rate is the starting point that financial institutions and large lenders use in determining an interest rate for a loan, it is by no means the only factor they’ll consider.
Credit score & credit history
Your credit score plays a vital role in the interest rate you’ll be granted for a large loan. The higher your score, the lower interest rate you’ll earn. Keep your score high by using your cards responsibly and paying your credit card bills on time.
Credit union difference
Here at Arizona Financial Credit Union, we also consider your credit history and the general state of your finances when determining your interest rate on a loan. If we see that you’re moving on an upward trajectory and working toward paying down your debts, we’ll be more likely to grant you a favorable interest rate on your loans.
Also, keep in mind that as a credit union devoted to your success, we're always striving to help you achieve and maintain financial wellness.
Arizona Financial members benefit from lower fees on transactions and competitive interest rates on loans than offered by most banks. While your specific interest rate may vary due to personal circumstances, you’ll know you’re always getting the best possible terms here at Arizona Financial.
The prime rate is an important element in the overall state of the U.S. economy and in your personal finances as well.
While you have no control over the rate’s rise and fall, you can do your part in keeping your interest rates low by maintaining a high credit score, living with financial responsibility and taking advantage of the excellent rates on products offered at Arizona Financial.
