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- What Are Netting Escrows & How Does It Work?: The Best Guide - January 2, 2024
- The Secret About Prescriptive Easement: Top Guide 1 Must Know - December 4, 2023
- About Home Equity Loans In Texas And How Can One Obtain It - November 27, 2023
Introduction to Prime Rate
Whether you take a personal loan, car loan, student loan, or mortgage, the lender will charge an interest rate on the borrowed amount as compensation for lending you the money.
But how does the lender derive the rate to be charged to the borrower on any of these loans?
Well, All the interest rates charged by the lenders depend on the prime rate. In this post, we will understand what is the prime rate and how it works in detail.
Prime Rate Definition
A prime lending rate is the interest rate charged by banks or lenders to their creditworthy customers or corporate borrowers.
It is one of the benchmarks used to determine the amount of interest that a lender would be charging the borrower.
How Does The Prime Rate Work?
Just like the rules of lending vary in the financial market so does the prime rate. Every lender or bank has its own prime interest rate.
The prime lending rate you see online when you search on any search engine is the daily rate calculated by the wall street journal which is an average of the multiple lenders’ prime lending rates.
The reason why the lenders issue prime interest rates or a rate closest to their most creditworthy borrowers is that they are less likely to default on a loan hence the risk of lending to such borrowers is less.
If the borrower is less creditworthy, the bank may charge a higher interest rate compared to the borrower with the best credit.
This lending rate is not a designated rate as the lowest possible interest rate as every lender has a different prime lending rate.
If you have good credit you might want to get quotes from multiple lenders so that you can compare and get the rate closest to the prime interest rate or even below it.
The prime rate is derived from the federal funds rate. The federal funds rate is a rate that is charged by the banks for lending money within themselves overnight with their excess reserve.
The federal funds rate is set by the Federal Reserve. This rate directly affects the prime lending rate. If the Federal Reserve increases this rate the prime interest rate will also increase and if the fed rate goes down so will the prime.
The prime interest rate is usually three percent over the federal funds rate. This means if the federal funds rate is two percent the prime lending rate would be five percent.
There is no set policy or regulation that the prime has to be three percent it could be higher or lower based on other market factors it is just an average over the years.
How Does Prime Lending Rate Affect You?
This rate is given by lenders to their most creditworthy borrowers. Hence it affects directly all the loan products like home equity loans, personal loans, car loans, student loans, credit cards, mortgages, etc.
Hence it is important for you to have a basic understanding of the prime lending rate if you are ever thinking of getting any type of loan.
Knowing this rate will help you understand what you are going to pay on the loan that you would be applying for.
Conclusion
The prime rate is the only thing that determines what interest rate you are going to pay on the borrowed money.
If you are in good credit standing it is suggested that you shop around with multiple lenders, as a result, you would be in a position to get an interest rate close to prime interest rate or maybe even lower.
While shopping for any credit product, ask your lender which rate they follow as the benchmark, and do your research about the same to make an informed financial decision.
