What is the Prime Interest Rate and How is it Determined?

As a business owner or homeowner, a loan application is among the most important steps that you can take to even out your chances of success or better living. However, it’s crucial to be knowledgeable and well prepared for the process as it can sometimes seem lengthy and overwhelming. This is especially true if it’s your first time applying for a loan. Familiarizing yourself with the terminologies lenders use not only increases your odds of approval, but it also helps you spot the early warning signs of getting overcharged.

If it’s your first time taking out a personal loan or a mortgage, there’s a big chance you may not be aware of what exactly some loan terms mean and how they affect loan repayment. During your loan application and the related processes that follow, you’re going to come across different terminologies that you may or may not be familiar with among them is the prime interest rate. In this article, we’ll be shedding more light on what the prime interest rate is and how it’s determined.


Prime Interest Rate Defined

You don’t need to be a finance Einstein to get your loan approved. However, you still want to ensure that your loan is fairly structured and the repayment terms will not jeopardize your finances or your business’s cash flow. Well, the prime interest rate, also commonly referred to as the prime rate, is the rate at which banks charge their best customers. It’s the best loan rate set to low-risk customers who have the highest credit ratings. Such borrowers get the best interest rates, whether it’s on their mortgage, personal loan. This is because they pose little to no risk to the lender.

The federal reserve is responsible for the changes you see happening on the prime interest rate and its these changes that will eventually affect how much interest rate you’ll be charged on your loan whether a mortgage, personal loan, auto loan or credit card. According to Julia Peoples from Loanry, when looking for a prime interest loan these are among the first things to understand. In addition, factors such as your creditworthiness and the type of loan you want may influence the rates you get on your loans. However, the baseline or the starting point will be the prime interest rate. But how exactly is prime interest rates determined? One may wonder. 


How the Prime Interest Rate Is Determined

The effects of the prime rate go beyond individual borrowers and will also influence the financial markets. Low prime rates make it easier to access affordable loans. This, in turn, increases liquidity and boosts economic growth. When the prime rate is high, there’s stunted economic growth and vice versa. All the same, below are various ways the prime interest rate is determined:

  • The Federal Reserve System – The Federal Reserve is responsible for setting what is known as the federal funds target rate. This is the rate used by banks when lending and borrowing money amongst each other.
  • The Wall Street Journal – This is a popular measurement of the prime rate that is commonly used in the US. It’s an international publication that strongly focuses on investments and corporate news. Anything published in the Wall Street Journal will have an impact on the trade market. The prime rate that gets published in the WSJ as the settled rate among the largest US banks will typically become the federal funds target rate. That’s how influential the Wall Street Journal is to the lending industry.


How Important Is The Prime Interest Rate To The Consumer?

Nearly all loan facilities base their interest rates on the prime rate as variations in the prime interest rate will significantly affect how affordable or expensive it becomes to take out a loan. This is perhaps why most people will prefer fixed interest rate loans because the interest rate is never affected by the variations posed on the prime interest rate. On the other hand, consumers who have loans with variable interests will experience changes in their monthly repayments when the prime interest rises or drops. This has an impact on your loan account’s minimum payments, including the interest charges.

Now, the term prime interest is not your everyday household term. However, it’s a primary consumer concern as it affects the overall interests charged on different types of loans. Keeping an eye on the prime rate fluctuations and understanding how it works will provide you with key incentives that will help you make the right borrowing decisions. Because at the end of the day, it’s about finding the most affordable loans and making sure that you’re able to pay them comfortably, lest your debts become burdensome.


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The views expressed in this article are those of the authors and do not necessarily reflect the views or policies of The World Financial Review.