The prime rate is the interest rate commercial banks use as a starting point for pricing short-term loans to their most creditworthy customers. Its formal name, in the Federal Reserve's H.15 statistical release, is the "bank prime loan rate"; almost everyone calls it the prime rate, and the version most often quoted is the one The Wall Street Journal publishes. It is not set by the government or by any single authority. Instead it tracks the Federal Reserve's policy rate by a stable convention, and it functions as the reference point off which a large share of variable-rate consumer credit is priced.
Prime Rate
The prime rate is the reference interest rate large banks use as a base for pricing short-term loans to their most creditworthy borrowers. It moves in step with the Federal Reserve's benchmark rate and sets the floor under many variable consumer loans.
Last reviewed by Steven Fox, CFP®, EA
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Quick Summary
- The prime rate is a base lending rate published by large banks; its formal name in the Federal Reserve's data is the "bank prime loan rate."
- For decades it has equaled the top of the Federal Reserve's federal funds target range plus 3 percentage points, so it moves whenever the Fed moves.
- Many variable consumer products, most credit cards and home equity lines of credit, are priced as "prime plus" a margin, so they change with it.
- It is a reference rate that banks post rather than one the government sets, and the most-cited version is the one published by The Wall Street Journal.
Definition
Advanced Explanation
Two things about the name are worth stating plainly. First, the official series the Federal Reserve reports is labeled the "bank prime loan rate," and its footnote describes it as the rate "posted by a majority of top 25 (by assets in domestic offices) insured U.S.-chartered commercial banks," adding that "prime is one of several base rates used by banks to price short-term business loans." Second, the number consumers and contracts actually reference is usually the Wall Street Journal prime rate, which the paper publishes based on a survey of the largest banks and updates when a consensus of them changes their posted prime. In practice all of these move together, so "prime rate," "bank prime loan rate," and "WSJ prime rate" refer to effectively the same number.
The prime rate is not independent of the Federal Reserve. For decades it has sat at a fixed spread above the central bank's policy rate: the prime rate has equaled the top of the federal funds target range plus 3.00 percentage points. So when the Federal Reserve raises or lowers its target, the prime rate moves by the same amount, on the same day, almost mechanically. This is why the prime rate is the main channel through which a Federal Reserve rate decision reaches ordinary borrowers: the federal funds rate is a rate banks charge one another, but the prime rate is the one printed in loan agreements.
That is where the prime rate matters most to a household. A large share of variable-rate consumer credit is priced as "prime plus a margin." A credit card might carry a rate of prime plus 12 percentage points; a home equity line of credit might be prime plus 1. When the prime rate changes, every such account reprices by the change, typically within a billing cycle, because the margin stays fixed and only the prime component moves. Fixed-rate loans, by contrast, are set at origination and do not follow the prime rate afterward, so the prime rate governs the cost of revolving and variable debt rather than a fixed 30-year mortgage.
How to Remember
Think of the prime rate as the Federal Reserve's decision translated into a number your credit card can read. The Fed moves its target; prime moves the same amount; your "prime plus" rate moves with it.
Used in a Sentence
“Because her home equity line was set at the prime rate plus one percentage point, every time the Federal Reserve changed its target Elena saw her line's rate adjust by the same amount on the next statement.”
How It Works
The prime rate is derived, not negotiated. Banks set it at a fixed spread over the Federal Reserve's policy rate, so the sequence runs: the Federal Reserve changes its federal funds target, banks adjust their posted prime by the same amount, and any loan priced as "prime plus a margin" reprices accordingly.
A hypothetical shows the pass-through. Suppose the prime rate is 8% and Rafael has a credit card priced at "prime plus 13," giving him a 21% rate on a $6,000 balance, about $1,260 a year in interest if the balance stays put. The Federal Reserve then cuts its target by half a percentage point, and the prime rate falls to 7.5%. Rafael's margin of 13 does not change, so his card rate becomes 20.5%, and his annual interest on the same balance falls to about $1,230. A hike would run the same arithmetic in reverse. The margin is what the lender keeps fixed; the prime component is what carries the Federal Reserve's decision onto his statement.
Pros and Cons
What makes the prime rate useful
- It is a transparent, widely published benchmark, so "prime plus" pricing is easy to compare across lenders once you know each margin.
- It moves predictably with the Federal Reserve's target, so borrowers can anticipate how a Fed decision will hit variable-rate debt.
What to watch out for
- Loans tied to it are variable, so payments on credit cards and home equity lines rise automatically when the prime rate rises.
- The prime rate is only the base; the margin the lender adds on top can be large, and that margin, not prime, is where most of a credit card's rate comes from.
- It applies to variable-rate credit, so it says nothing about the cost of a fixed-rate loan set at origination.
People Also Asked
Answers to the most frequently asked questions.
Why is it called the "bank prime loan rate"?
"Bank prime loan rate" is the formal name the Federal Reserve uses for the series in its H.15 release; the footnote defines it as the rate posted by a majority of the largest U.S. commercial banks as a base for short-term loans. Everyone else calls it the prime rate, and the most commonly quoted version is the one The Wall Street Journal publishes. They all refer to effectively the same number, so the different names are not different rates.
How is the prime rate related to the federal funds rate?
The prime rate tracks the Federal Reserve's policy rate by a long-standing convention: it equals the top of the federal funds target range plus 3.00 percentage points. So when the Federal Reserve raises or lowers its target, the prime rate moves by the same amount, usually the same day. The federal funds rate is what banks charge each other; the prime rate is the version that shows up in consumer loan contracts.
What loans are tied to the prime rate?
Mostly variable-rate consumer credit. Most credit cards and home equity lines of credit are priced as "prime plus a margin," so their rate changes whenever the prime rate changes, typically within a billing cycle. Some personal loans and small-business loans use it too. Fixed-rate loans set at origination, such as a standard 30-year mortgage, do not follow the prime rate afterward.
Does the government set the prime rate?
No. The prime rate is set by banks, not by the government or the Federal Reserve directly. What the Federal Reserve controls is its own policy rate, and the prime rate follows it by convention. Because that spread has held at 3 percentage points for decades, the prime rate moves in lockstep with the Fed's decisions even though no authority mandates the number.
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