The Fed (U.S.) Prime Rate

The U.S. Prime Rate is a commonly used, short-term interest rate in the banking system of the United States. All types of American lending institutions (traditional banks, credit unions, etc.) use the U.S. Prime Rate as an index or foundation rate for pricing various short-term loan products. The Prime Rate is consistent because banks want to offer businesses and consumers loan products that are both profitable and competitive. A consistent U.S. Prime Rate also makes it easier and more efficient for individuals and businesses to compare similar loan products offered by competing banks.

When newspapers, academics, investors and economists refer to the National, Fed, U.S. or WSJ Prime Rate, it is widely accepted that they are in fact referring to The United States Prime Rate as listed in the Eastern print edition of the Wall Street Journal® (WSJ). Furthermore, each U.S. state does not have its own individual Prime Rate, so the "New York Prime Rate" or the "California Prime Rate" are in fact the same as the United States Prime Rate.

Traditionally, the WSJ Prime Rate was determined by polling thirty (30) of America's largest banks. When twenty-three (23) of those 30 banks had changed their prime lending rate, The WSJ would respond by updating its published Prime Rate. Effective December 16, 2008, however, the WSJ now determines the Prime Rate by polling the 10 largest banks in the United States. When at least 7 out of the top 10 banks have changed their Prime, the WSJ will update its published Prime Rate.

Providers of consumer and commercial loan products often use the U.S. Prime Rate as their base lending rate, then add a margin (profit) based primarily on the amount of risk associated with a loan. Moreover, some financial institutions use Prime as an index for pricing certain time-deposit products like variable-rate Certificates of Deposit.

It's important to note that the Prime Rate is an index, not a law. Consumers and business owners can sometimes find a loan or credit card with an interest rate that is below the current Prime Rate. Lenders will sometimes offer below-Prime-Rate loans to highly qualified customers as a way of generating business. Furthermore, below-Prime-Rate loans are relatively common when the loan product in question is secured, as is the case with home equity loans, home equity lines of credit and car loans.

The U.S. Prime Rate is invariably tied to America's cardinal, benchmark interest rate: the Federal Funds Target Rate (also known as The Fed Funds Target Rate.) The Fed Funds Target Rate is set by a committee within the Federal Reserve system called The Federal Open Market Committee (FOMC). The FOMC usually meets every six weeks, and it is at these meetings that the FOMC votes on whether or not to make changes to the Federal Funds Target Rate. When the Fed Funds Target Rate changes, it is almost a certainty that the Wall Street Journal Prime Rate will also change. If the FOMC votes to make no changes to The Fed Funds Target Rate, then it is almost a certainty that the WSJ Prime Rate will also remain unchanged. Since the second quarter of 1994, a rule of thumb for the U.S. Prime Rate has been:

U.S. Prime Rate = (The Fed Funds Target Rate + 3)

The FOMC's primary objectives are to keep inflation under control and maintain steady economic growth with maximum sustainable employment within the United States.

The U.S. Prime Rate is used by many banks to set rates on many consumer loan products, such as student loans, home equity lines of credit, car loans and credit cards. If you read or hear about a change to the U.S. Prime Rate, then any loan product that is tied to the Prime Rate will also change, like variable-rate credit cards or certain adjustable-rate mortgages.

Click here for more information about how the U.S. Prime Rate works.

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