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Prime Rate

Candlefocus Editor
The prime rate has been a long-established financial benchmark that is used to determine the lending and borrowing costs of the most creditworthy corporate customers. It is based on the Federal Funds Rate (FFR), which is the interest rate that banks charge each other for overnight loans of U.S. government securities. Here, the Federal Reserve Bank sets the benchmark based on external factors and the prevailing demand for interbank loans. Thus, it is this FFR that commercial banks quote for their most creditworthy customers.

Basically, commercial banks use a FFR + 3 to determine the current prime rate, though the exact number is up to the individual bank. Because of the nature of the market, the prime rate can change quite quickly. The Wall Street Journal (WSJ) publishes the most up-to-date prime rate on a daily basis. This rate is the benchmark for all other lending institutions, including mortgage lenders, credit cards issuers, and small business loan providers.

In general, lenders will charge their most creditworthy clients the prime rate while others receive an interest rate based on their credit score as well as other factors deemed pertinent. A lower credit score can mean a rate that is three or four points above the prime rate, or even higher. A good score could mean a rate lower than the prime rate, depending on the lender.

The prime rate continues to be an important financial standard that helps to set the safety mark for other loan interest rates. It is important to note that the prime rate is not directly related to the Prime Rate Index which is an index based on U.S. Treasury yields. In other words, the Prime Rate Index is more of an indicator of market trends and is not always reflective of actual prime rate.

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