Why is Prime Rate Important?

January 23, 2020, by Sara McPherson

Written by: Michael Mims, Managing Director, Private banking

The Prime Rate or Prime Lending Rate is generally accepted as the interest rate banks charge their best clients.  Prime Lending Rate changes anytime the Federal Open Market Committee (FOMC) changes the Fed Funds Rate (this is the rate banks charge each other for overnight lending reserve requirements).  As a rule of thumb, most banks set their prime rate at three percentage points higher than the federal funds rate, however, some banks will charge more.

The main reason the Prime Rate is important is because most all lending institutions base their consumer based variable rate loans (and some commercial loans) on Prime Rate or some percentage above the Prime Rate. A change in the Prime Rate typically means an immediate change in the amount a consumer pays for credit on adjustable rate loans. Some examples include credit cards, student loans, Home Equity Lines of Credit, etc.

To give you a perspective of the history of the Prime Rate, since its inception in 1947, the Prime Rate mean average over that period of time is 9.69%.  The Prime Rate mean average over the past 25 years is 7.73%. For the past decade, the Prime Rate mean average has been historically low at 4.45%.

We caution our clients to be mindful of carrying large balances on variable rate loans if they are near their comfort level of monthly debt service since changes in the Prime Rate are outside of their control and can happen at any time.