The prime rate is the interest rate major banks offer to their borrowers with the best credit — in other words, the least risky ones.
This key benchmark jumped for the third time this year, after the Federal Reserve increased its policy rate by three-quarters of a percentage point to try to quell runaway inflation.
The two rates move together, and the new increase means higher borrowing costs for car loans, home equity lines of credit and credit cards.
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What is the prime rate today?
The current prime rate among major U.S. banks is 4.75%.
The prime rate normally runs 3 percentage points above the central bank’s federal funds rate, which the Fed just raised to a target range of 1.5% to 1.75%.
And the prime rate is expected to keep moving upward this year because the Fed is predicting a series of increases to try to stabilize the prices of goods.
What is the current prime rate?
Before the Federal Reserve’s less aggressive quarter-point increase in March, the prime rate hadn't budged since March 2020.
That's when the Fed responded to the coronavirus crisis by slashing the benchmark rate to a range of just 0% to 0.25%. At that time, major banks cut the prime from 4.25% to 3.25%.
Fed policymakers held their federal funds rate close to zero throughout the worst of the pandemic. The prime rate stood still too throughout that time, with the prime rate at major banks remaining at its lowest level since the mid-1950s.
But now, Federal Reserve Chair Jerome Powell says the economy and job market are so strong that the nation can handle interest rate increases to help tamp down consumer demand to better align with the supply of goods.
In March of last year, officials didn't see rate hikes coming before 2024. That has changed with the steepest inflation in four decades.
Now, you may be getting the impression that the Fed sets the prime rate. It doesn't, though there is a close relationship between the prime rate and the Fed's federal funds rate.
Prime rate definition
The prime rate is a key lending rate used to set many variable interest rates, such as the rates on credit cards and home equity lines of credit, or HELOCs.
Technically, there is no single U.S. prime rate. Banks set their own prime rates, but they're generally all the same and move in lockstep with the Fed's benchmark rate.
It's the prime rate that commercial banks offer to their most creditworthy customers — including corporations, and consumers with the highest credit scores.
Borrowers who are considered more likely to default — that is, not pay back a mortgage or other loan — get higher rates.
Who sets the prime rate?
The prime rate piggybacks off the federal funds rate, which is one of the Federal Reserve's primary tools for nudging the economy. Banks typically take that rate and add 3 percentage points to get their prime rate.
The prime rate is used to set interest rates for credit cards and also can influence personal loans and certain mortgages.
When banks' prime rates are low, there is more lending, borrowing and spending activity in the market. That activity tends to slow when prime rates are higher, which in turn tempers the economy and inflation.
The federal funds rate is the interest rate banks charge each other for overnight loans so they can meet their reserve requirements. Those are the amounts of money the Fed requires banks to have on hand at the end of each business day, partly to guard against bank failures.
The central bank doesn't exactly set the federal funds rate; it's ultimately decided by market supply-and-demand forces. But the Fed's policymaking panel — called the Federal Open Market Committee, or FOMC — establishes a target for the federal funds rate.
The rate throughout the pandemic matched an all-time low established during the 2008-2009 financial crisis and Great Recession.
WSJ prime rate
The Wall Street Journal publishes what's considered to be the definitive U.S. prime rate, which is determined through a survey.
As the publication explains, its Wall Street Journal prime rate is "the base rate on corporate loans posted by at least 70% of the 10 largest U.S. banks."
Though the Journal's prime rate generally matches the prime rate posted by the big banks — again, normally the federal funds rate plus 3 points — it's considered the official prime rate that's used to set many other borrowing costs.
How does the prime rate change?
The federal funds rate — and, in turn, the prime rate — has a direct impact on certain types of credit, namely loans with rates that are adjustable, not fixed. The prime rate influences other interest rates in a more roundabout way.
The historical prime rate
The prime rate and variable-rate loans
Interest rates on those products change in sync with the prime rate. The adjustable rate on a HELOC might be advertised as "prime plus 1%" or "prime plus one," for example.
The interest rate on that hypothetical home equity line would have risen from 5% to 5.75% when the benchmark rate increased. Again, the current prime rate is 4.75%.
In similar fashion, a credit card might have an annual percentage rate, or APR, described as "prime plus 11.49%" or "prime plus 9.99%."
The prime rate and other types of loans
Interest rates on auto loans are often tied to the U.S. prime rate too, and many adjustable-rate mortgages, or ARMs, adjust in tune with the prime rate.
The interest on ARMs is fixed for the first several years, then it moves up or down along with a benchmark interest rate — often the prime rate. A common adjustable-rate mortgage is the 5/1 ARM, with an interest rate that's fixed for five years and can adjust every one year after that.
The interest rates on personal loans and popular fixed-rate mortgages do not dovetail with the prime rate and the federal funds rate, but there is an indirect effect on what borrowers pay.
After the Fed cut its federal funds rate to near zero last year and created a climate for very low interest rates, mortgage rates dropped to historic lows. Rates on personal loans fell too.
But long-term mortgage rates don't always move in the same direction as the prime. For example, 30-year mortgage rates fell from December 2016 to December 2017 — even as the prime rate rose from 3.75% to 4.5%.
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This article provides information only and should not be construed as advice. It is provided without warranty of any kind.