Understanding the Prime Rate and How it Affects You
The prime rate is a benchmark interest rate used by banks to set the interest rates on various loans, including mortgages, credit cards, and personal loans. It is used as a reference point to determine the cost of borrowing money and can have a significant impact on your finances. In this article, we will explore what the prime rate is, how it is determined, and how it can affect you.
What is the Prime Rate?
The prime rate is the interest rate that banks charge their most creditworthy customers, also known as the “base rate.” It is typically 3% higher than the federal funds rate, which is the rate at which banks lend money to each other overnight. The prime rate is used as a benchmark for other interest rates, such as the rate on a mortgage or a car loan.
How is the Prime Rate Determined?
The prime rate is determined by the Federal Reserve, which sets the federal funds rate. The Federal Reserve uses this rate to influence the economy by controlling the cost of borrowing money. The prime rate is typically 3% higher than the federal funds rate.
How the Prime Rate Affects You
The prime rate can affect you in a number of ways, depending on the type of loan or credit you have.
Mortgage Rates
One of the most significant ways the prime rate can affect you is through mortgage rates. When the prime rate goes up, so do mortgage rates. This means that if you are in the process of buying a home or are considering refinancing your current mortgage, a higher prime rate can increase your monthly mortgage payments.
Credit Card Rates
The prime rate can also affect the interest rate on your credit cards. Many credit card companies use the prime rate as a benchmark for determining the interest rate on your card. If the prime rate goes up, so will the interest rate on your credit card, which can result in higher monthly payments.
Personal Loans
Personal loan interest rates are also often tied to the prime rate. If the prime rate goes up, the interest rate on your personal loan will also increase, which can make it more expensive to borrow money.
Auto Loans
Auto loan interest rates are also affected by the prime rate. When the prime rate goes up, so do auto loan rates, making it more expensive to purchase a vehicle.
Saving and Investment
On the other hand, when the prime rate goes down, it can make saving and investing more attractive. Lower interest rates on savings accounts and CDs can make it more difficult to grow your savings, while lower yields on bonds can make them less attractive investments.
The Prime Rate History Over the Last 5 Years
The prime rate may change anytime, depending on the economy. It may fluctuate once, twice, or four times a year. There are also times when it does not change for the entire year. Just like in 2021. To give you an idea of how the prime rate changes over the years, here are the fluctuations in the past 5 years.
Prime rate changes in 2017
In March 2017, the prime rate increased to 4%. It was the first time it reaches 4% since 2008. It continues to increase in June, making it 4.25%. Before 2017 ended, another fluctuation happened making it 4.50%.
Prime rate changes in 2018
In March 2018, the prime rate continues to increase four times. It raises to 4.75% in March. 5% in June. 5.25% in September. Then it rises to 5.50% by the end of the year, December 2018.
Prime rate changes in 2019
The prime rate finally decreased by the third quarter of 2019. It reduces to 5.25% in August 2019 from 5.50% in December of the previous year. Another reduction happened by October making it 4.75%.
Prime rate changes in 2020
Drastic changes in the lowest interest rate happened in 2020 when it has a huge decrease in just one month. The first reduction happened on March 04, 2020, which makes it 4.25% from 3.75% in the previous year. Then after just two weeks, on March 17, 2020, a 1% decrease happened reducing it to 3.25%.
Prime rate changes in 2021
The rate remains at 3.25% until March 17, 2022.
Prime rate changes in 2022
The aftermath of the pandemic in the economy reflects in the fluctuation of the prime rate in 2022. It quickly increases from 3.25% to 5.50%. The rate increased to 3.50% in March. Then it continues to increase to 4% in May. 4.75% in June. Then 5.50% in July.
What Triggers the Prime Rate to Fluctuate?
The prime rate is determined by the Federal Reserve, the central bank of the United States, and based on the Federal Fund Rate. The Federal Fund Rate is the interest rate that the financial institutions charge on each other when one borrows from another. The prime rate is determined as 3% higher than whatever the current federal fund rate is. For instance, if the federal fund is 1%, 3% will be added to determine the prime rate. Hence, 4% will be the prime rate.
If the federal fund rate increases, the prime rate will also increase. When the prime rate increases, so are the loan interest rates.
How Does the Prime Rate Affect You?
The prime rate determines loan interest rates. So, if you are planning to take out a loan for a non-emergency purpose, it’s a good practice to check the prime rate first. This will help you decide on whether to pursue the loan or wait a little longer as the interest rate may decrease soon. Aside from that, it also has a great effect on the economy. As the prime rate decreases, the economy flourishes. This is because low-interest rates allow business owners to get more funds to expand their business. This can also result in cheaper prices in the market because businesses do not struggle from paying high-interest rates.
Can The Future Prime Rates Affect your Current Loans?Â
If you take out a loan today payable for 5 years, will the prime rate in the next 4 years still affect your loan interest rate? It depends. If your agreement has a variable interest, then the future prime rate will affect the future interest rate of your current loan. This means that your interest rate will go up or down depending on the prime rate fluctuations.
It is best to pay loans as soon as possible to avoid getting stocked in paying high-interest rates. Plus, struggling to pay loans on time can have significant negative effects on your credit score. Note that a poor credit score leads to high-interest rates. Your credit score is one of the main factors to get the lowest interest rates on loans. So, keep it in excellent condition as much as possible.
