What’s the prime rate and how does it affect what I pay for credit?
What you need to know about prime rates, who determines them and how they affect you.
Have you ever wondered how lending companies determine interest rates for consumer loan products, such as credit cards or auto loans? If so, you’ve probably heard of a prime rate, which can be a complicated concept. Here are the most common questions and how to easily understand them.
What’s a prime rate and how is it determined?
A prime rate is an index used by banks to set rates. This is determined by the Federal Reserve System, which has a committee that keeps tabs on the economy and sets what they believe to be a healthy standard for banks to lend money.
In addition to the Federal Reserve System, The Wall Street Journal also provides a prime rate standard after surveying the largest banks in the United States. For them, this rate usually ends up being about 3% more than the federal fund target rate (which is determined by the Federal Open Market Committee and changes throughout the year).
According to Investopedia, “A prime rate is the interest rate that commercial banks charge their most creditworthy customer,” they explain on their website. “The prime rate is important for individual borrowers, as the prime rate directly affects the lending rates available for a mortgage, small business loan or personal loan.”
Click here to take a look at a prime rate history since 1947 (Hint: It was way lower back then!).
How does this affect consumers?
Credit Karma explains that “if your credit card has a variable APR (annual percentage rate) that changes with the prime rate, your rate will fluctuate along with the prime rate. If the prime rate goes up, it’s more than likely that variable APRs will, too”
Similarly, bankrate.com states that the terms of such loans typically are expressed as prime plus a certain percentage, depending on the borrower’s credit rating and other factors.
Another consideration, as explained by The Balance, is that “if interest rates stay too high for too long, it causes a recession, which creates layoffs as businesses slow. If you are in a cyclical industry, or a vulnerable position, you could get laid off.”
Who – or more accurately, what – qualifies for prime rate?
Thestreet.com explains that “because the prime rate is the best interest rate available by commercial banks to non-banks and customers, it is generally given to corporations that use commercial banks for loans or credit, or especially creditworthy customers (those with the highest credit scores) seeking credit cards or other loans from banks.”
With that being said, if you’re trying to get the best possible rate for your mortgage, personal loan or credit card, make sure to do everything you can to improve your credit score before applying. Remember that a few things that will help your credit score increase (checking it does not hurt it) are eliminating any debts in collections, reducing your debt-to-income ratio, making payments on time, and not applying to new credit cards.
What should I do about my credit rates?
Even though prime rates are out of your control, there are other things you can do to be fully aware of what’s going on with your finances. When applying for mortgage loans or credit cards, people tend to look for the option that provides the most perks, cash back, and best terms of repayment. As important as these deciding factors are, however, most consumers fail to ask why they’re receiving a certain rate and how this is compared to what’s happening in the economy at that moment.
By keeping up with prime rate changes and reviewing the “How We Calculate and Determine Rates” section of your loan (yes, that’s a thing! Here’s another tool you can try), you’ll get a better understanding of what you’re paying for and have the knowledge to make educated financial decisions.
LendingPoint is a personal loan provider specializing in NearPrime consumers. Typically, NearPrime consumers are people with credit scores in the 600s. If this is you, we’d love to talk to you about how we might be able to help you meet your financial goals. We offer loans from $2,000 to $25,000, all with fixed payments and simple interest.