Prime Rate

Prime Rate summary:

• The prime rate is a benchmark rate. Some financial institutions use it as a starting point to set their interest rates.

• Banks set their prime rate based on another benchmark, the federal funds rate.

• Many lenders set their interest rates using the prime rate as a base. For example, your credit card interest rate might be “prime plus 13.99%.”

Prime rate definition and meaning

The prime rate is an interest rate some banks use to set rates for different types of loans. The prime rate isn’t what everyday borrowers pay. Lenders use it as a starting point.

Banks often set their prime rate based on another interest rate, this one called the federal funds rate. The federal funds rate is established by the government and represents the rate at which banks lend money to one another overnight. 

Changes to the prime rate can affect the cost of borrowing money. When the prime rate increases, loans and lines of credit typically cost more. When the prime rate decreases, loans can become less expensive. 

More about the prime rate

Prime rate is a finance term you may not use often, but it's important to understand if you need a loan. The prime rate is a benchmark rate that some banks use to decide what to charge their most creditworthy borrowers. 

Banks often set their prime rate based on changes to the federal funds rate. If you've never heard of the federal funds rate, it's the rate banks use to lend to one another overnight. The Federal Reserve periodically decides whether to raise or lower this rate. 

Why should you care about the prime rate? In simple terms, it has the power to affect what you pay to borrow. 

Prime rate and loans

Some lenders base their interest rates on the prime rate. Loans that may use the prime rate can include:

• Adjustable-rate mortgages (ARMs)

• Home equity lines of credit (HELOCs)

• Credit cards

• Personal loans

• Business loans

If you plan to get a new loan or line of credit, you can ask the lender how interest rates are set and whether the prime rate is a factor. 

Other loans base interest rates on something other than the prime rate. Federal student loan rates, for example, are set by Congress each year.

How does the prime rate affect interest rates?

When you get a loan or credit card, your loan agreement should include a breakdown of how your interest rate is calculated. You can use that breakdown to understand how the prime rate affects the rate you pay. For example, your credit card rate may be the prime rate plus 13.99%. That means if the prime rate is 5%, your rate will be 18.99%. 

Does the prime rate affect savings account rates?

The prime rate has no direct impact on the interest you earn on savings accounts. 

Banks can use the federal funds rate to set savings account rates. If the Fed cuts this rate, then you may earn less interest on your savings. If the Fed raises rates, then savings account rates can follow suit.