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What is the Prime Rate and How Does it Affect Me?

You’ve probably heard of about the prime rate before. But what exactly does it mean and how does it affect you and your interest rates? Here are a few things you should know about the prime rate.

What is the Prime Rate?

The prime rate is a foundational interest rate commonly used to determine short-term interest rates for consumers. It’s foundational because it’s generally the lowest rate a lender will charge its best customers. Most often, the prime rate is used as a basis, or point of reference, for determining interest rates depending on a borrower’s risk for defaulting on a loan. In other words, if a borrower has a low risk of default based on credit score and other factors, her interest rate will be closer to the prime rate (and vice versa).

How is the Prime Rate Determined?

Prime rates may differ between lenders. But in general, the prime rate used by individual lenders follows the Wall Street Journal’s prime rate, which is usually about 3 percent higher than the federal funds rate, or the rate banks charge each other for overnight lending.

Which Loans Follow the Prime Rate?

The prime rate is the underlying index that dictates the interest rates for most credit cards, home equity loans and lines of credit, auto loans, and personal loans. So, when the prime rate goes up, your variable interest rates will usually follow. These loans are usually expressed as prime plus a certain percentage, which is determined by your credit rating and other factors. If you want to safeguard against possible interest rate hikes, some loans offer fixed rates. You can even find credit cards with a low fixed APR.

How Can You Follow the Prime Rate?

There are ways to track the prime rate. The Wall Street Journal, for example, publishes the most widely quoted measure of prime rate. The publication surveys large banks and publishes the consensus prime rate. By tracking the prime rate, you can know whether your variable interest rates may be going up or down. And you can get an idea about the base interest rates your lender may be currently offering.

How does the Prime Rate Affect You?

The prime rate is outside of your control. But understanding the prime rate and being aware of sometimes unpredictable changes in interest rates can help you stay on top of your payments and help you minimize your credit card debt.

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