Individual banks determine the prime rate, which is a short-term rate that typically serves as a benchmark for other interest rates. Rates on products like adjustable mortgages and credit are influenced by the prime rate, so consumers are affected, too.
Take a look at six important elements regarding the current prime interest rate so you can better understand changes in the prime rate, how the Wall Street Journal plays a role, and how you're affected by fed rate hikes.
1. Federal Funds Rate Determines the Prime Rate
Although individual banks set the prime lending rate, many use the federal funds rate as a guide. The Federal Reserve Open Market Committee sets the federal funds rate, which is the interest rate member banks charge each another for short-term loans.
The FOMC works with the Federal Reserve Board of Governors to control the three tools of monetary policy that help maintain a stable U.S. economy. The FOMC uses its tools to attain the ideal economic growth rate, which is between 2 and 3 percent. The fed funds rate increases as economic growth accelerates — and when the fed funds rate changes, the prime rate does, too.
2. The Best Borrowers Get the Prime Rate
Banks give the prime rate to their most creditworthy customers, including corporate borrowers with the highest credit ratings. So, if you're starting a small company and you're in need of capital, it's unlikely you'll get the prime rate for your loan. A large, well-capitalized firm is more likely to receive the prime rate when it borrows funds to finance a new project.
3. The Prime Lending Rate Has Been Low Since 2008
JPMorgan Chase & Co., one of the world's oldest and premier financial institutions, lists its prime rate history for the past 34 years. On March 16, 2017, the rate was 4 percent, up one-quarter of a percent since Dec.15, 2016.
The lowest prime interest rate since the turn of the century was set during the financial crisis at 3.25 percent on Dec. 16, 2008. The prime lending rate has traded in the historically low range of 3 percent to 4 percent since October 2008 — these rates reflect the low fed funds rate and the Federal Reserve Bank's attempt to spur economic growth after the recession from 2007 to 2009.
4. The Wall Street Journal Prime Rate Is Accepted as the Standard
The Wall Street Journal lists the current prime rate. Although it isn't uniform across all banks, the Journal prime rate is widely accepted as the standard. The Journal reports the U.S. prime rate based on the rate that at least 70 percent of the 10 largest U.S. banks use. On March 16, 2017, it listed the U.S. prime rate at 4 percent, which was the 52-week high rate. The lowest prime rate during the previous 52 weeks was 3.5 percent.
5. The Prime Interest Rate Has Been Low in the Past 10 Years
During the past 10 years, the prime interest rate has been at historically low levels. During the early 1980s, it hovered above 10 percent and hit a high of 13 percent in June 1984, according to the JPMorgan Chase & Co. prime rate chart.
Imagine paying double-digit mortgage rates for your new home purchase in the 1980s. Being knowledgeable about interest rate history helps put the current low rates in perspective and keep you alert for possible higher interest rates in the future — and their ramifications.
6. Rising Interest Rates Hurt Borrowers
The recent interest rate surge might increase average APR credit card rates, which can result in people paying off more than their minimum balances each month to avoid paying high interest rates, according to CNBC. Be a smart consumer and review your credit card's annual percentage rate, then read the fine print to see if it's tied to the prime interest rate. If you can't pay off the balance, consider a 0 percent interest rate balance transfer. Keep an eye on the prime rate — once you know how hikes will impact you, you'll be able to make a number of wise financial decisions.
Institutions that provide consumer and commercial loan products often use the U.S. prime interest rate as their base lending rate and add a margin — to make a profit — that's primarily based on the amount of risk associated with the loan. Some banks use the prime rate as an index for pricing certain time-deposit products like variable-rate certificates of deposit.
How Prime Interest Rates Can Impact You
The prime interest rate serves as a benchmark for many consumer-related interest rates. Home equity loans, lines of credit and credit card rates typically tie into the Journal's published prime rate.
Adjustable mortgage rates might also be affected by the prime interest rate, and sometimes your adjustable-rate mortgage will be stated as prime plus a certain percent. So, if your adjustable-rate mortgage is prime plus 2 percent, your interest rate today would be 4 percent plus 2 percent for a total of 6 percent. When the prime rate increases, your adjustable rate will go up according to the terms of your mortgage contract.
Unlike an adjustable-rate mortgage, interest rates for home equity loans and lines of credit adjust immediately rather than once a year. If you're worried about rising rates, however, you can typically convert your balance to a fixed-rate option.
If you plan to buy a new car in the near future, one rate change typically will not have an effect on the interest rate you get. A quarter percentage point difference on a $25,000 loan amounts to $3 a month, which likely won't break your budget.
Keep Reading: 7 Reasons Why You're Getting That Interest Rate Today