The interest rate charged by lenders to their best, most creditworthy customers.
A less creditworthy customer may be offered a loan at a prime rate plus anywhere from 2 percent to 10 percent. Borrowing at below-prime also occurs, but is less common and usually applies to businesses rather than individual customers.
The prime rate is the lowest interest rate available to most customers. Banks charge different rates for different types of loans and different kinds of customers. They charge their best customers, most often businesses, the prime rate. Building and maintaining a good credit history are two of the most important qualifications for prime-rate borrowing.
The Federal Reserve, often called The Fed, determines whether to lower or raise the prime rate based on a variety of economic factors. Many consumer loans, such as auto, home equity, mortgage and credit card loans, are based upon the prime rate. Your home equity loan, for example, might have an interest rate of the prime rate plus 1 or 2 percentage points.
The interest rate on some types of loans, such as adjustable rate mortgages, will rise and fall with the prime rate. That doesn’t happen with a conventional mortgage, where the rate is locked in for the term of the loan -- regardless of what happens with the prime rate.
In general, the prime rate goes up when the Federal Reserve is concerned about rising inflation. Higher interest rates can help slow down portions of the economy that contribute to inflation. Lowering the prime rate can help stimulate the economy by making loans more affordable.
The Fed meets approximately every six weeks to review economic factors. The schedule is important if you’re applying for a loan: You might want to close on the loan before the next meeting if knowledgeable parties think the Fed is likely to raise the prime rate, or wait until after the meeting if it looks like the rate might drop.
It doesn’t matter which lender you are using. Almost all banks adjust the prime rate at the same time.