prime rate

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n.
The lowest rate of interest on bank loans at a given time and place, offered to preferred borrowers. Also called prime interest rate.


base rate that banks use in pricing commercial loans to their best and most creditworthy customers. The rate is determined by the Federal Reserve’s decision to raise or lower prevailing interest rates for short-term borrowing. Though some banks charge their best customers more and some less than the official prime rate, the rate tends to become standard across the banking industry when a major bank moves its prime up or down. The rate is a key interest rate, since loans to less-creditworthy customers are often tied to the prime rate.
For example, a Blue Chip company may borrow at a prime rate of 5%, but a less-well-established small business may borrow from the same bank at prime plus 2, or 7%. Many consumer loans, such as home equity, automobile, mortgage, and credit card loans, are tied to the prime rate. Although the major bank prime rate is the definitive “best rate” reference point, many banks, particularly those in outlying regions, have a two-tier system, whereby smaller companies of top credit standing may borrow at an even lower rate.

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The lowest commercial interest rate charged by banks on short-term loans to their most creditworthy customers. The prime rate is not the same as the long-term mortgage rate, though it may influence long-term rates. Also, it is not the same as the consumer loan rate that is charged on personal property loans and credit cards.
Mortgage rates and consumer loan rates are generally higher than the prime rate, but exceptions occur at times.


Example: Bank of America and Citigroup offer a prime rate of 7%.
Chevron/Texaco is a prime customer and at that rate may borrow loans up to 270 days. Bank of America offers construction loans at 4
points over the prime rate.

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This entry contains information applicable to United States law only.

The lowest rate of interest that a financial institution, such as a bank, charges its best customers, usually large corporations, for short-term unsecured loans.

The prime lending rate is an economic indicator and is often used as a measuring point for adjusting interest rates on other types of loans. The rate varies according to economic factors.

The interest rate that banks charge to corporations that are considered excellent risks.

  • The prime rate is usually the lowest prevailing interest rate; if it rises, rates available to consumers will soon rise.

  • The interest rate that commercial banks charge their most credit-worthy customers. Generally a bank's best customers consist of large corporations. The prime interest rate, or prime lending rate, is largely determined by the federal funds rate, which is the overnight rate which banks lend to one another. The prime rate is also important for retail customers, as the prime rate directly affects the lending rates which are available for mortgage, small business and personal loans.

    Investopedia Says:
    Default risk is the main determiner of the interest rate a bank will charge a borrower. Because a bank's best customers have little chance of defaulting, the bank can charge them a rate that is lower than the rate that would be charged to a customer who has a higher likelihood of defaulting on a loan.

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    Prime rate or prime lending rate is a term applied in many countries to a reference interest rate used by banks. The term originally indicated the rate of interest at which banks lent to favored customers, i.e., those with high credibility, though this is no longer always the case. Some variable interest rates may be expressed as a percentage above or below prime rate.

    Contents

    Use in different banking systems

    United States and Canada

    Historically, in North American banking, the prime rate was the actual interest rate although this is no longer the case. The prime rate varies little among banks, and adjustments are generally made by banks at the same time, although this does not happen with frequency. The prime rate is currently 3.25% in the United States,[1] and the Canadian prime rate is currently 3.00%.[2]

    Historical chart of the effective Federal Funds Rate

    In the U.S., the prime rate runs approximately 300 basis points (or 3 percentage points) above the federal funds rate, the interest rate that banks charge to each other for overnight loans made to fulfill reserve funding requirements: (federal funds rate) + (3 %) = (prime rate). The Federal funds rate plus a much smaller increment is frequently used for lending to the most creditworthy borrowers today, as is LIBOR, the London Interbank Offered Rate. The Federal Open Market Committee (FOMC) meets eight times per year wherein they set a target for the federal funds rate. Other rates, including the prime rate, derive from this base rate.

    Prior to December 17, 2008, when 23 out of 30 of the United States' largest banks changed their prime rate, the Wall Street Journal would change its published rate. On December 17, 2008, the Wall Street Journal recognized that fewer, but larger banks controlled most assets and changed the methodology for the prime rate that is published. The Journal's rate today now reflects the base rate posted by at least 70% of the top ten banks by assets.

    Uses

    The prime rate is used often as an index in calculating rate changes to adjustable rate mortgages (ARM) and other variable rate short term loans. It is used in the calculation of some private student loans. Many credit cards and home equity lines of credit with variable interest rates have their rate specified as the prime rate (index) plus a fixed value commonly called the spread or margin.

    See also

    References

    1. ^ According to data published by The Wall Street Journal Online and the Federal Reserve Bank. "Federal Reserve Statistical Data". Federal Reserve. http://www.federalreserve.gov/releases/h15/data/Monthly/H15_PRIME_NA.txt. 
    2. ^ According to data published by Bank of Canada. "Daily Digest- Rates and Statistics- Bank of Canada". Bank of Canada. http://www.bankofcanada.ca/en/rates/digest.html. 

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