The prime rate is the best interest rate that major banks extend to their borrowers with the best credit. Find out how the prime interest rate affects you.
The prime rate explained
The prime rate is a key lending rate that's used to set many variable interest rates, such as the rates on credit cards. In December, banks raised the prime from 5.25% to its current level of 5.5%.
Despite a common misunderstanding, changes in the prime are not made by the Federal Reserve, though the prime rate is closely tied to the federal funds rate. That's the benchmark interest rate that the Fed controls.
Each time the central bank gives the federal funds rate a nudge, the big banks almost immediately make a similar move with the prime.
When Fed policymakers hiked their rate by another one-quarter of one percentage point in December, banks responded with their quarter-point increase in the prime rate.
Why the prime rate moves
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 interest rate goes up, too.
If you're unhappy about rising interest rates, look at it this way: They typically go up whenever the economy is growing. And that's a positive thing!
What the prime rate means for you
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 6.5% as the prime rises to 5.5%.
You can expect to pay higher interest on your plastic or your HELOC soon after any Fed rate hike.
The prime rate and other loans
Rates on auto loans, personal loans and some adjustable-rate mortgages also piggyback off the prime.
And while fixed 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 likely to hold rates steady in 2019, and mortgage giant Freddie Mac expects little change in 30-year fixed mortgage rates, too.
But 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.