What Is the Prime Mortgage Rate?
What is the Prime Mortgage Lending Rate?
If you’re borrowing in the United States, anything from a credit card to a mortgage loan is partially impacted by a number called the “Prime Rate.” This figure is shrouded in mystery, but also easily located daily in the Wall Street Journal. Its impact on banking, however, is significant and extends far beyond housing.
What Determines the Prime Rate?
The Prime Rate is often confused with the Federal Funds Rate, a rate at which banks lend money to one another and is determined by the Federal Reserve. This is what you hear about on the news when the Fed meets. It’s not the same as the Prime Rate, though the Prime Rate often follows the Federal Funds Rate.
The Prime Rate is set by individual banks, which means it can vary between individual banks. What the Wall Street Journal reports as the Prime Rate is actually the rate posted by at least 70 percent of the top ten largest banks in the US by assets each day. They don’t always agree, which is why the Wall Street Journal uses the 70 percent mark.
So, long story short, the Prime Rate is determined by banks, on an individual basis. It just happens that they also generally price it off of the Federal Funds Rate, plus about 300 basis points (that’s three percent), give or take.
How is the Prime Rate Used?
This is where it gets a little tricky. The Prime Rate is the rate that banks loan money to their best customers: large corporations. Everything else flows from there. Banks charge an excellent rate to their customers who are at low risk of defaulting, in the form of the Prime rate plus some small profit amount. However, a bank will hike the profit percentage on top of the Prime rate for riskier borrowers.
Other types of credit, like credit cards or auto loans, are also frequently based on the Prime Rate of the issuing bank. Again, like with mortgages, these loans will be priced as Prime, plus some amount of profit that corresponds to your risk level. Banks don’t always disclose that they’re pricing against their Prime Rate; instead, they just give a flat number to customers. This can make it easier to understand since with fixed-rate loans it really doesn’t make much difference.
What Influences the Prime Rate?
Each bank has its own criteria for their Prime Rate’s behavior, but some very influential factors include:
- The Federal Funds Rate
- Changes in other banks’ Prime Rate
- Economic pressure, like a recession
Because banks set their own Prime Rate, they can also raise or reduce it at will. If they want more new customers, for example, they might drop their Prime Rate so that loans across the board are cheaper. They could also just offer discounted loans that are below Prime for really good borrowers who probably have friends they can tell about the bank’s great deals.
Prime is just that. The best rate the bank offers, except when they offer a lower rate.
What You Need to Know About Prime Rates
The Prime Rate isn’t really what you need to pay attention to. Instead, look at mortgage rates for the types of mortgages that you’re interested in exploring. These also can vary across banks, depending on how much profit they build into the loan. The Prime Rate is often an intermediate step in the mortgage pricing process and one that can really confuse the situation.