how the prime rate works
an interest rate is the percentage of a loan amount that a lender charges it is the lender s compensation and the percentage varies with each type of loan generally any unsecured loan such as a credit card balance is charged interest at a higher rate than a secured loan such as an auto loan or a mortgage the rate that an individual or business receives will vary depending on the borrower s credit history and other financial details these rates are normally defined as an annual percentage rate apr the prime interest rate which is also called the prime lending rate is largely determined by the federal funds rate set by the fomc of the federal reserve the fed funds rate is the overnight rate banks and other financial institutions use to lend money to each other the process is a constant electronic flow of money that ensures that each bank has sufficient liquidity to operate from day to day banks generally use a formula of federal funds rate 3 to determine the prime rate it charges its best customers primarily large corporations that borrow and repay loans on a more or less constant basis 5that prime rate is the starting point for all other interest rates which are set at the prime rate plus an additional percentage the bank sets a range of interest rates for each loan type the rates individual borrowers are charged are based on their credit scores income and current debts for example a person with an outstanding credit score might be charged say prime plus 9 for a credit card while an individual with only a good score might get a rate of prime plus 15 the prime rate plus a percentage forms the base of almost all consumer and business interest rates determining the prime ratethe prime rate is determined by individual banks and used as the base rate for many types of loans including loans to small businesses and credit cards the federal reserve has no direct role in setting the prime rate but most financial institutions choose to set their prime rates based partly on the target level of the federal funds rate established by the fomc 4one of the most used prime rates is the one that the wall street journal publishes daily as noted above banks generally use fed funds 3 to determine the prime rate the prime rate in the united states as of early february 2024 is 8 5 as it has been since july 27 2023 1 at that time the fed funds rate was set at a target of between 5 25 and 5 5 2the prime rate had increased since may 2022 moving in tandem with the fomc s increases to the fed funds rate to combat high inflation 61although other u s financial services institutions regularly note any changes that the fed makes to its prime rate and may use them to justify changes to its prime rates institutions are not required to change their prime rates following the fed s decisions the prime rate changes daily in line with other interest rates a snapshot of the prime rate can be found on the federal reserve s website 