When you're reading financial news, you're likely to see reports discussing the "prime rate".
The U.S. prime rate, published daily by the Wall Street Journal, is based on the interest rates that 10 of the nation's largest banks charge their most creditworthy customers for borrowed money. The prime rate is an important indicator for national interest rates and is an estimate of the lowest qualifiable rate a person or business can get on a loan or line of credit. In order to receive the prime rate, you must have an excellent credit score.
The prime rate changes when the nation's largest banks decide it needs to rise or fall. The prime rate may not change in a given year (like in 2002, it held steady at 4.25%) but it's also changed several times in a single year (such as in 2008, when the prime rate changed 7 times, starting at 6.50% and gradually fell to 3.25%).
Prime Rates and Your Credit
Credit card issuers and banks base their variable interest rates off of the prime rate.
For example, assume the rate for borrowing money through a credit card equals the prime rate plus 13%. The interest your credit card issuer charges in addition to the current prime rate is known as "the spread." If the current prime rate is 5.50%, and the spread is 13%, the total interest on your variable-rate card would be 18.50%.
The prime rate also has a direct impact on the finance charges you pay for carrying a credit card balance. The higher the prime rate, the more you'll pay to resolve credit card debt. If your credit card has a variable interest rate (meaning it fluctuates over time), what you pay to use it will follow the movement of the prime rate.
You can avoid paying any interest on credit cards by paying your balance in its entirety each month, and you should diligently monitor your statement to watch for changes in your interest rate.
Keep this in mind if you need to make a large purchase, and compare your own rate with movement in the prime rate.
The chart below illustrates the difference between the prime rate and commercial bank interest rates from 2000-2019.
Preparing for a Prime Rate Increase
In the 1980's, the American population saw the prime rate change a whopping 38 times, starting the year at 15.75% and topping out at an all time high of 21.50%.
Predictably, when the prime rate increases, so will your interest rates on any existing balances. Here are three tips for reducing the personal impact of increased interest rates and finance charges:
- Pay off your credit balances as quickly as possible, either on the due date each month or whenever you make a purchase.
- Transfer multiple balances to a single credit card with a 0% introductory rate.
- If you've kept your card and credit score in good standing, your credit card issuer may be willing to temporarily lower your interest rate if you ask directly.
The section of your credit card agreement titled: "How We Calculate and Determine Rates" will tell you how your credit card issuer sets your rate, and how your personal rate will adjust in relation to the prime rate.
Knowledge is Power
Knowing the current prime rate at any given time will help you decide if assuming debt is a manageable choice for your future, your family, or your business. If you're considering a variable interest rate for a large debt, study the recent history of interest rate fluctuations, and keep a close eye on the prime rate once you're managing your payments. Virtually all borrowed money has a connection to the prime rate, including the totality of American credit cards, mortgages, home equity lines of credit, and automotive or student loans.