Prime interest rate that is also termed as ‘prime lending rate’ is charged by the lenders to the credit worthy clients who borrow from them. The Prime interest rate becomes the benchmark that plays a vital role in deciding the interest rates within the existing system. Prime interest rate determines interest rates for home equity, mortgages and other variable rate loans. These rates also influence the student loan interest rates.
The prime interest rates are used for calculating the interest rates that the banks charge on loans and credit cards. Banks offer prime rate to customers with higher credit ratings and greater ability to repay their loans.
The Prime lending rates or interest rates are of different kinds. Prime lending rates include home-equity fixed rates, long term prime lending rates, short term prime lending rates, home equity-variable rates and many more. Each bank announces its prime lending rates and changes the rates once in 3-6 months.
Prime interest rate is considered to be three percent more than the declared federal funds rate approximately. The Federal Funds Rate is the rate charged by banks among each other for holding short term funds. The Federal Open Market Committee sets a Federal Reserve Discount Interest Rate that influences the federal funds rate. The directors of the Federal Reserve Banks have the final word on these discount rates.
Prime interest rate affects the economy of a country in general. It influences the liquidity in the financial world. Low interest rate takes the liquidity higher since the loans are less costly. Less expensive loans can be got easily and will be popular among borrowers. These loans will help the customers expand their business which will improve the country’s economy manifold.
The increase in the prime interest rates or lending rates will deplete the liquidity in the market. Consequently, the country will face economic slowdown. Taking this factor into consideration, the banks normally increase the prime interest rate only when federal funds rate is raised.
Any bank that offers loans to the customers considers the risk of defaulting, on the part of the customers to be its greatest problem. This default risk, normally determines the interest rates declared by the banks. The best clients or customers of a bank are well known for repaying their loans promptly without defaulting. Many banks encourage such loyal customers by giving them prime rates that are lower than the normal interest rates offered by the bank. A customer, who has a history of defaulting, might not receive this privilege and might be charged higher interest rates.
Prime rate serves like an index and the rate is not a law. There are banks that offer interest rates below the said prime interest rate. These banks ensure that their customers receive incentives and use this as a marketing strategy to generate more business. Customers who offer substantial collateral have the chances of getting prime interest rates. Prime lending rates or prime interest rates are the banks’ way of expressing their applause and gratitude to their credit worthy clientele.