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What Is the Prime Rate?

Nov 15, 2007
Many people have heard of the prime rate but may not be exactly sure what it is or how it can affect their lives. Truth is the prime rate can be very influential to most consumers who use most types of credit or home mortgages.

In general terms, the prime rate is the interest that banks or other types of credit lenders charge their most preferred and credit-worthy customers. Many times lenders who offer various types of loans such as credit cards and automobile loans will use the prime rate as a base rate upon which they will add their profit. Personal loans as well as certain types of business loans may use the prime rate as the base rate. Most types of personal loans and just about all credit card companies charged interest rates that are at least a few points higher than the prime rate. A point in this case is equal to one percentage point.

Consumers should understand that as their creditworthiness decreases due to late payments and such, the interest rates that they will be offered for future loans will increase. This same principle also applies to the economy as a whole. As the national level of creditworthiness declines the interest rates that banks and other lenders offer will usually increase. It is also important for consumers to understand that prime rates can and do vary from bank to bank.

Just because banks can set their own prime rate does not mean they do so without a lot of thought. Often banks and other lenders will set their prime rate at a level that has been set by the largest commercial banks. Others may research what other smaller lending institutions are charging and set their rate at or near that level.

Banks may charge various rates for various types of loans and credit. The prime rate is used as base point and from there points are added to reflect the profit that the bank wants to make on the loan. This is why the rate for a credit card from your bank may not be the same rate as charged for a home loan.

There is no hard and fast rule but the usual prime rate set by banks is about three percentage points higher than the Federal Rate. The Federal Rate is the rate that banks charge each other as they lend to each other. In turn, the federal funds rate is determined by the rate at which banking institutions borrow from the Federal Reserve. That rate is called the discount rate.

As you can see the rate for money increases as it moves up the line to the bank itself and then a little more is added to it so that it can move to the consumer. Those who get the best rates of all are usually corporate customers who are less likely to default on their loans. However, consumers with good credit histories may also benefit some from a bank that is willing to give them the lower prime rate as well. The only way to know if your bank will charge you their prime rate is to ask.
About the Author
Peter Kenny is a writer for The Thrifty Scot, please visit us at Consolidation Loan and Compare Saving Accounts
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