Prime Rate

?The prime interest rate is important to consumers because a lower rate increases liquidity by making loans less expensive and easier to obtain.

The prime rate is the interest rate commercial banks charge their most creditworthy customers, which are usually corporations and not necessarily other banks. The prime rate is also known as the prime lending rate, and it is based on the Fed Funds rate. The prime interest rate is important because it governs the liquidity in the financial markets and a low prime rate increases liquidity by making loans less expensive, and easier to obtain.  This means that when prime lending rates are low, businesses are more likely to expand, as will the overall national economy.

Because different banks charge different interest rates, when people refer to the prime rate they are actually talking about the average rate among the nation’s largest banks and the most common source for this statistic in the U.S. is the Wall Street Journal that calculates and publishes the average prime rate by looking at surveys of the rates charged by the 30 largest banks in the U.S.  There are usually no wild swings in the prime rate because the rate is usually very similar for nearly all the surveyed banks, and they will all usually change their rates at nearly the same time. It is only when 75% of the surveyed banks (that means 23 banks) change their rates, that the Wall Street Journal will publish a new average rate.

The prime rate is an important financial indicator because it is a major factor is setting both mortgage (fixed and adjustable rates) and credit card rates for consumers. This is visible when looking at a home equity loan that might be rated as "prime plus 4" when the actual prime rate is 6%. The numbers actually mean that the bank is offering borrowers a 10% loan (prime plus 4) with an interest rate that will rise or fall along with the prime rate. It is important to remember that not all borrowers can qualify for a bank's prime rate as it is only offered to those customers who are least likely to default. One more thing to remember about the prime rate is that it is affected by the Federal Funds rate that is set by the Federal Reserve Bank. The Federal Funds rate determines the rate banks can borrow from each other or from the Federal Reserve in order to meet their reserve requirement obligations.