The prime rate, sometimes called the prime interest rate or prime lending rate, is the rate at which banks lend funds to their most reliable and creditworthy customers. It’s influenced by the federal funds rate set by the Federal Reserve.
Banks use the prime rate as a starting point or benchmark to help determine the range of interest rates for the different products they offer – the interest rate for financial products is set using the prime rate as a basis. The range of interest rates offered will also depend on the type of loan or credit. Other financial factors can also determine which rate you get as a borrower, including your income, creditworthiness and debt-to-income ratio.
Read on for more information on the prime rate, including how it’s set and what it can affect.
How is the prime rate set?
The prime rate’s main influence is the federal funds rate set by the Federal Reserve. The federal funds rate is the interest rate at which banks lend each other money overnight.
Each bank determines its own prime rate – this is part of why interest rates can vary by institution. Typically, the prime rate is the federal funds rate plus an additional percentage. The prime rate can differ depending on the institution, but it is typically roughly the federal funds rate plus 3 percentage points.
Lenders don’t offer the prime rate for every type of loan or type of credit. The prime rate is the benchmark or starting point for the other interest rates banks and institutions offer. Banks set up a range of interest rates for each loan or type of credit. The range depends on the type of product and whether the loan is secured or unsecured. The rate you receive will also depend on your financial factors, such as creditworthiness, DTI and income.
What can the prime rate affect?
The prime rate can affect a variety of interest rate for financial products – any new fixed or variable-rate loans or lines of credit or existing variable-rate loans or credit cards that use the prime rate as a benchmark.
The rate you receive for a new fixed-rate loan, such as a mortgage or personal loan, can depend on the prime rate. This is true for new variable-rate loans as well – the prime rate can influence the current interest rate. If you have a variable-rate loan or line of credit, the interest rate may change based on the prime rate.
What loans aren’t impacted by changes in the prime rate?
Existing loans with fixed rates are not typically affected by changes in the prime rate. For example, if you have an existing fixed-rate mortgage, the rate will not change when the prime rate changes. This is generally true for any existing loan or line of credit with a fixed interest rate.
If the prime rate isn’t the benchmark for the loan – for example, the bank may use a different interest rate, such as the SOFR rate – then the prime rate may not affect the interest rate.
Disclosure: This article is for educational purposes. It is not intended to provide legal, investment, or financial advice and is not a substitute for professional advice. It does not indicate the availability of any Citi product or service. For advice about your specific circumstances, you should consult a qualified professional.
