'Prime Rate' is explained in detail and with examples in the Corporate Finance edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.
The Prime Rate is the most typically utilized shorter term interest rate for the United State banking system. All kinds of lending institutions in the United States employ this U.S. benchmark interest rate as a basis or index rate to price their medium term to short term loans and products. This includes credit unions, thrifts, savings and loans, and commercial banks.
This makes the Prime Rate consistent around the country as banks strive to be competitive and profitable in their lending rates which they provide to both consumers and businesses. A universal rate like this simplifies the task for businesses and consumers as they shop around comparable loan products that competing banks offer. Every state in the country does not maintain its own benchmark rate. This makes a California Prime or New York Prime identical to the U.S. Prime.
Commercial and other banks charge this benchmark rate to their best customers. These are those clients who have the best credit ratings and loan history with the bank. Most of the time banks’ best clients are made up of large companies.
The prime interest rate is also known as the prime lending rate. Banks typically base it on the Federal Reserve’s federal funds rate. This is actually the rate that banks loan money to each other for overnight purposes. Retail customers also need to be aware of the prime lending rate. It directly impacts the lending rates that they can access for personal and small business loans as well as for home mortgages.
The federal government and Federal Reserve Bank do not set the prime lending rates. The individual banks set it. They then utilize this base rate or reference rate to set the prices for a great number of loans such as credit card loans and small business loans.
The Federal Reserve Board releases a statistics called “Selected Interest Rates.” This is their survey of the prime interest rate as the majority of the twenty-five biggest banks set it. It is this publication which reveals the Prime Rate periodically. This is why the Federal Reserve does not directly set this important benchmark rate. The banks more or less base it on the target level of the federal funds rate that the Federal Open Market Committee sets and changes at their monthly meetings.
Different banks adjust their prime lending rate at the same time. The point where they change it is generally when the Federal Open Market Committee adjusts their own important Fed Funds Rate. Many publications refer to this periodically changing reference rate as the Wall Street Prime Rate.
A great number of consumer loans as well as commercial loans and credit card rates find their basis in the prime lending rate. Among these are car loans, home equity loans, personal and home lines of credit, and various kinds of personal loans.
The rates above the prime lending rate that banks charge their less then prime (or subprime) customers depend on the credit worthiness of the borrower in question. The banks attempt to correctly ascertain the risk of default for the borrower. For the best credit customers who have lower chances of defaulting, banks can afford to assess them a lower interest rate than others. Customers with higher chances of defaulting on their loans pay larger interest rates because of the risk associated with their loans not being repaid.
As of June 15, 2016, the Federal Open Market Committee voted to maintain its target fed funds rate in a range of from .25% to .5%. As a result of this, the U.S. prime lending rate stayed at 3.5%. Once per month the Federal Reserve committee meets to determine if they will change the fed funds rate.