What Is the Current Prime Rate and How Does It Affect You?
The prime rate affects almost all individuals and organizations in some way, typically determining how much interest they’ll have to pay on bank-borrowed money. The prime rate stands at 5.50%, effective July 28, 2022 — an increase from the previous rate of 4.75%. This rate helps commercial banks and lending institutions figure out how much interest they’ll charge their customers.
The Federal Reserve, which controls the prime rate, has raised it four times this year. Here’s a closer look at what the prime rate is and how it affects the average consumer.
What Is the Prime Rate?
The prime rate is a special interest rate that commercial banks charge their most valuable clients. Also known as the prime interest or lending rate, the prime rate is determined largely by the 10 largest U.S. banks and is based on the federal funds rate, or the percentage that financial institutions use to lend to each other.
In practical terms, the prime rate is what other interest rates — personal and small business loans, for example, as well as mortgages — are based on.
To qualify for a prime rate loan, individuals or organizations must have a very high credit score. Corporations and high-net-worth individuals easily qualify for this kind of loan because they are low-risk borrowers. Even if individuals and organizations don’t qualify for this type of loan, the prime rate still affects the interest rate they’ll have to pay on other loan types.
The Federal Reserve’s open market committee holds eight regulatory meetings each year to review and assess current U.S. economic and financial conditions to determine whether the federal funds rate should be adjusted. The federal funds rate is typically lowered when the economy slows down to spur economic growth and is raised when the economy grows too fast to prevent inflation.
Who Sets the Prime Rate?
Unlike the typical interest rate, which is determined by the government, the prime rate is decided by the 10 largest U.S. banks by using the federal funds rate to determine what the prime rate should be. Here’s how the prime rate is determined:
The U.S. Federal Reserve sets the federal funds rate that banks can use when lending each other money.
Banks use this federal funds rate as a base to set their interest rates when they lend out to other banks to meet their reserve requirements.
The Wall Street Journal carries out research to determine the interest rate banks are using to charge other banks for loans. It publishes this rate as the prime rate.
What Is the Current Prime Rate?
As of late July 2022, the prime rate stands at 5.50% — an increase from 3.25% at the same time a year earlier. Here’s a historical snapshot of how the prime rate has fluctuated during the past three years.
Date | Rate |
|---|---|
July 28, 2022 | 5.50% |
June 16, 2022 | 4.75% |
May 5, 2022 | 4.00% |
March 17, 2022 | 3.50% |
March 16, 2020 | 3.25% |
March 4, 2020 | 4.25% |
Oct. 31, 2019 | 4.75% |
Sept. 19, 2019 | 5.00% |
Aug. 1, 2019 | 5.25% |
How Does the Prime Rate Affect Consumers?
The current prime rate affects the rate consumers are offered on a variety of loans. While high-net-worth individuals and the largest, most stable corporations typically qualify for prime rate loans, the average consumer may not but will still feel its effects. That’s because banks use the prime rate to set their interest rates for mortgages, small business loans, personal loans and credit cards.
Here are two ways the prime rate affects consumers.
Influences the Interest Charged on Almost All Loans, Including Credit Cards and Mortgages
Banks use the prime rate to determine their interest rates. Ideally, these financial institutions set their rates at an amount that’s higher than the prime rate. This is to cover the big risk of default by their regular clients.
That means consumers — as well as businesses and nonprofits — will pay higher interest rates on their loans when the prime rate rises.
Impacts the Liquidity of the Financial Market, Making It Easier — Or Tougher — To Obtain a Loan
Liquidity is high when the prime rate is low. Under these conditions, banks have more than enough money to lend at reasonable rates. This makes qualifying easier for consumers who need a personal or small business loan or are looking to refinance their home mortgages.
When more consumers qualify for loans easily and inexpensively, businesses generally thrive and so does the U.S. economy.
By contrast, when liquidity is low, the prime rate drops. That means funds are more scarce and not readily available. Loans become much more expensive, which means fewer people can qualify for them.
When these conditions are in place, the country typically experiences a slowdown in economic growth.
What Does the Prime Rate Affect?
The prime rate has a strong influence on two loan types. Here’s a closer look at each one.
Adjustable-Rate Mortgages
Adjustable-rate mortgages are home loans that have variable interest rates. These rates are applied in two stages. The first — the introductory phase — is the teaser rate. That means it has a lower interest rate and usually lasts for one to 10 years.
When the introductory phase ends, the rates generally adjust and the second stage kicks in. This is when the prime rate starts to apply. Banks will include the current prime rate in their interest rates to determine the amount they’ll charge on a mortgage loan, for example.
If the current prime rate is high, the interest rate on a mortgage loan will be high, too. If the current prime rate is low, the mortgage interest rate will also be low.
Credit Cards
Banks base their credit card interest rates on the prime rate. With the prime rate at 4.75% before the July 28 increase, a credit card issuer’s interest rate is around 17.5%, according to CreditCards.com. That is the highest rate since September 2019. The increase of the prime rate to 5.50% will very likely increase credit card interest rates, too.
Put simply, when the prime rate increases, a customer will have to pay a higher interest rate on their credit card balances. When the prime rate decreases, they’ll have to pay less.
What Isn’t Affected by the Prime Rate?
Most loan interest rates set by commercial banks are based on the prime rate, but some aren’t. Those that aren’t affected by the prime rate include:
Fixed-rate loans. These include personal loans, auto loans, credit card loans or mortgages with fixed interest rates.
Federal student loans. Congress periodically determines and evaluates interest rates on federal student loans.
Is the Prime Rate the Only Factor That Banks Use To Determine Interest Rates?
While banks and other lending institutions base their interest rates on the prime rate, it’s not the only factor they consider. An individual’s credit rating plays a significant role in the interest rate a bank will charge. The higher the applicant’s credit rating, the lower the interest rate applied.
This is why it’s important for individuals seeking loans to keep their credit rating high by using their credit cards responsibly. They should also pay their credit card bills promptly.
Final Take
Many people who seek bank loans aren’t familiar with the prime rate, yet this percentage affects a majority of other interest rates that are charged. Knowing the current prime rate will help anyone looking to take a loan to decide whether it’s the right step for their future, their family and their business.
Anyone looking to take out a huge loan should research the history of interest rate fluctuations and monitor the prime rate when managing their repayments. It could pay to defer the purchase of an item the requires a loan until the Fed warrants the economy can handle a rate decrease.
Jami Farkas contributed to the reporting for this article.
This article originally appeared on GOBankingRates.com: What Is the Current Prime Rate and How Does It Affect You?
