prime rate
The interest rate that commercial banks charge their most creditworthy corporate customers, typically 3 percentage points above the federal funds rate.
Example
“When the Fed raised rates by 0.25%, the prime rate automatically increased from 8.25% to 8.50%.”
Memory Tip
PRIME RATE = the reference rate for bank loans. Fed funds rate + 3%. Your loan rate is prime + X%.
Why It Matters
The prime rate affects the interest rates you pay on variable-rate loans like credit cards, home equity lines of credit, and adjustable-rate mortgages. When the prime rate changes, your borrowing costs can increase or decrease, directly impacting your monthly payments and total interest paid over time.
Common Misconception
Many people believe the prime rate is set by the Federal Reserve, but it is actually determined by individual banks based on the federal funds rate. Banks use the prime rate as a benchmark, but they can adjust it independently based on their own lending policies and market conditions.
In Practice
If the federal funds rate is 5 percent, the prime rate would typically be around 8 percent. A credit card company might then charge you 18 percent interest, which is the prime rate of 8 percent plus their markup of 10 percent. When the Federal Reserve raises the federal funds rate to 5.5 percent, the prime rate moves to 8.5 percent, and your credit card rate automatically increases to 18.5 percent.
Etymology
PRIME (first quality, best) RATE. The best (PRIME) RATE offered to the best customers.
Common Misspellings
Learn economics & finance from top universities
Related Terms
More in economics
Other economics terms you should know
See Also
Need financial definitions?
Clear definitions for 2,500+ finance, insurance, and investing terms.