Glossary

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Prime Rate

Definition

The Prime Rate is a commonly used short-term interest rate in the US banking system. It’s the benchmark rate lenders use to set rates for their most credit-worthy customers. The best customers may be granted loans at rates below Prime.

Versions

There are several versions of the Prime Rate, including National, Fed, U.S. or WSJ. However, when most publications discuss the Prime Rate, it is widely accepted that they are referring to The United States Prime Lending Rate as listed in the Eastern print edition of the Wall Street Journal® (WSJ). 

How the Prime Rate is set

The Prime Rate is not set by the Federal Reserve, Congress or any legal entity. It’s just an index. WSJ now determines the Prime Rate by surveying the ten largest banks in the United States. When at least seven of the ten change their Prime, the WSJ updates its published Prime Rate.

What it's used for

The Prime Rate is used for setting interest rates for many short-term financing options, including:

  • credit cards
  • personal lines of credit
  • commercial loans
  • construction financing
  • and more.

Affect of credit score on

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

The Federal Reserve, often called The Fed, determines whether to lower or raise their 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.

What cause it to go up?

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.

 

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