We adhere to strict standards of editorial integrity to help you make decisions with confidence. Please be aware that some of the products and services linked in this article are from our sponsors.
The prime rate: Sounds pretty important and impressive, doesn't it? It's not just an ordinary interest rate -- it's prime! But what does that mean exactly?
This is a good time to be asking, because the prime has been rising and is going up again. Let's find out what the prime rate is -- and isn't.
The prime rate explained
The prime rate is the best interest rate that major banks extend to their borrowers with the best credit. Think of it as the banks' "best rate."
Despite a common misunderstanding, the prime is not set by the Federal Reserve, though it is closely tied to the federal funds rate. That's the benchmark interest rate that the Fed controls.
Each time the central bank makes a change in the federal funds rate, the big banks almost immediately make a similar move with the prime.
Federal Reserve policymakers just hiked their rate by another one-quarter of one percentage point. Banks responded by hiking the prime from 5% to 5.25%.
Why the prime goes up or down
Federal Reserve officials set their target for the federal funds rate based on how well the economy’s growing and the outlook for inflation.
The Fed tends to lower its interest rate in times of high unemployment, a sluggish economy or weak inflation. And that pushes down the prime.
But whenever the economy is booming in a way that could heat up inflation, the central bankers raise the federal funds rate to keep spending and prices under control. And the prime rate goes up, too.
If you're unhappy about rising interest rates, look at it this way: They're going up because good economic growth is expected for 2018 and 2019. And that's a positive thing!
How the prime affects you
If you've got credit cards (and who doesn't?) or a home equity line of credit, better known as a HELOC, you feel the movements in the prime rate most directly.
Rates on those products change in lockstep with the prime. In fact, the adjustable rate on a HELOC might be advertised as "prime plus 1%" or "prime plus one," for example.
That means the rate on a hypothetical home equity line will go to 6.25% as the prime rises to 5.25%.
You can expect to pay higher interest on your plastic or your HELOC soon after the Fed makes its decision.
The prime and other loans
Rates on auto loans, personal loans and some adjustable-rate mortgages also piggyback off the prime.
And while other mortgage rates don't necessarily follow the lead of the federal funds rate and the prime, they can be influenced by those benchmarks indirectly.
The Fed is expected to keep raising rates through the end of 2018 and beyond, and mortgage giant Freddie Mac expects 30-year fixed mortgage rates to climb, too.
Timing is crucial when you’re deciding to borrow money. If you’re in the market for a mortgage, an auto loan or a personal loan, you may want to latch onto a lower rate while you can!
Follow us on Twitter: @moneywisecom