# United States Prime Rates

## Current Wall Street Journal Prime Rate is:

## 3.25%

#### December 16th, 2020 - Federal Reserve Update

The Prime Rate will remain at 3.25% because the Federal Open Markets Committee (FOMC) meeting on December 16th, 2020 left the Fed Funds Rate unchanged at 0% - 0.25%. As the Prime Rate is linked to the Fed funds rate, the difference being approximately 3%, the prime rate will remain the same for the foreseeable future. The FOMC has chosen to leave the Fed funds rate unchanged and at a low level in order to spur the economy due to the negative effects of the pandemic. The Fed will continue purchasing assets such as treasury bonds in order to increase the money supply and keep interest rates low. In the future, the Fed will slow down the purchase of assets, however, the Fed Funds Rate will remain low for 2021. Therefore, it is expected for the Prime Rate to also remain at the 3.25% level for 2021.

## Prime Rates of Major Banks

JPMorgan Chase Bank | Banks of America | Wells Fargo Bank | Citibank |
---|---|---|---|

3.25% | 3.25% | 3.25% | 3.25% |

Bank | Prime Rate |
---|---|

JPMorgan Chase Bank | 3.25% |

Banks of America | 3.25% |

Wells Fargo Bank | 3.25% |

Citibank | 3.25% |

## What is the US Prime Rate?

The Prime Rate, also known as the **Prime Lending Rate** or **Prime Interest Rate** is the interest rate commercial banks charge on financial products such as loans and mortgages for their **most creditworthy customers**. These creditworthy customers have the least likelihood of defaulting on their obligations and payments to the lender. In most cases, the customers with the highest credit ratings are **corporate clients**.

## How is the Prime Rate determined?

The Prime Interest Rate is different for each lender, therefore, different banks can quote varying Prime Rates. For example, Bank of America can set a prime rate of 3.25%, whereas Wells Fargo may have a prime rate of 3.5%. Therefore, there can be ** several different Prime Rates**. In the US, the Wall Street Journal is the ** most quoted source** for the Prime Rate. The Journal surveys the 30 largest banks by assets and posts the consensus rate among them. The Wall Street Journal updates the Prime Rate only when 23 out of the 30 banks change their Prime Rate.

## The US Federal Reserve and Prime Rate

Although the US Federal Reserve (Fed) does **not** set the Prime Interest Rate, **it does impact it**. The Prime Interest Rate is determined by the Fed Funds Rate, which is the rate US banks charge to lend to each other overnight. Banks use this Fed Funds Rate as a starting point to determine the Prime Lending Rate for their most creditworthy customers, in most cases it is ** 3% or 300bps** above the Fed Funds Rate. For example, if the Fed Funds Rate = 0.5%, the US Prime Interest Rate would equal 0.5% + 3% = 3.5% on average.

### How is the Prime Rate calculated?

** US Prime Rate = Fed Funds Rate + 3% (300bps)**

### What is a Basis Point or bps?

Basis Point is a unit of measurement in finance for interest rates or other rates. Basis Points are useful when values are especially small making it hard to use percentages or absolute values.

1 bps is equal to 1/100th of 1% or 0.0001

100 bps is equal to 1% or 0.01

300 bps is equal to 3% or 0.03

Therefore, if the Fed decides to increase the Fed Funds Rate, making it more expensive for banks to lend to each other, the banks will accordingly increase the Prime Rate for their customers. Hence, even though the Fed does not officially set the Prime Rate, it does impact it through the Fed Funds Rate. The Fed meets 8 times a year to determine the appropriate Fed Funds rate.

## Recent Prime Rate Changes

In March, due to the negative effects of the COVID-19 pandemic the Fed initiated two emergency rate cuts to increase investments and spur the economy. These rate cuts decreased the Fed Funds rate which led to the decrease in the Prime Rate.**Currently the Fed Funds Rate is in the range of 0 - 0.25% and the Prime Rate today is accordingly 3.25% which is 3% above the upper limit of the Fed Funds Rate. ** The current Prime Rate is the **lowest** it has been since 2008!

## How does Prime Rate affect you?

Prime Interest Rates affect you because they ** form the basis for how lenders determine interest rates ** for financial products such as personal loans, credit cards, and loans for small and medium sized enterprises. The Prime Rate is also used as the **base or reference rate** for Adjustable Rate Mortgages and other variable rate loans. If there is an increase in the Prime Interest Rate, in most cases there will be an increase in the interest rates used for other loans also.

## Why do lenders charge different customers different interest rates?

The reason banks charge their most creditworthy customers a different rate as compared to others is because of ** default risk. ** Default risk is the risk taken by the banks when they lend money to customers who might not be able to pay back the loan or interest payments. Large corporations are less likely to default on their loans and hence they receive the Prime Interest Rate. Customers who are more likely to default such as individuals with a lower credit score are charged the Prime Interest Rate plus an **additional margin** (credit spread) because of higher risk.

### What is a Credit Spread?

Credit spread is the difference between the benchmark interest rate and the interest rate charged on the loan or financial product. The benchmark interest rate can be the Fed Funds Rate, Prime Interest Rate, 5-year Treasury yield, or London Interbank Offered Rate (LIBOR). These benchmark indices act as the reference or base rate as they pose the lowest risk lenders and institutions are willing to take. Above the benchmark is the credit spread that customers are charged based on several factors such as risk tolerance of the lender, customers financials (such as credit score), the type of financial product, and a margin for profit. The credit spread is the premium lenders charge customers because they have a higher default risk or likelihood of not paying back the loan. Credit spread is measured in basis point (bps)

For example, if the benchmark rate on a loan is 5%, and the lender charges an interest rate of 8% based on your financial strength, the credit spread is 3% or 300bps (8% - 5%).

If lenders notice that their top customers (i.e. corporations) are finding it difficult to repay their debt and their credit is dropping, this can be an indicator of higher default risk. The lenders or banks will ** increase the credit spread ** they charge their customers. The higher spread will include the additional risk of lending money and will result in ** higher interest rates ** on loans.

## How are the Fed Funds Rate, Prime Rate and Interest Rate connected?

The Fed Funds Rate, the Prime Rate and the interest rate on different loans are all **linked. **A change in the Fed Funds rate by the Fed will result in changes in the other two rates.

The Fed determines the Fed Funds Rate. The Prime Rate is based on the Fed Funds Rate with an additional 3%. Finally, the bank determines the interest rate it charges on its loans by adding a certain Interest Rate Spread to the Prime Rate.

However, it is important to note that apart from the Fed Funds Rate, which is the same for the entire country, the Prime Rate and Interest Rate charged by banks depends on the individual banks and their risk tolerance. Therefore, the interest rate you receive on your home loan can be better if you have a higher credit score even with the same prime rate because the extra interest rate spread is smaller. For example, if the Prime Rate for Wells Fargo is 3.25% and you want to get a variable-rate mortgage, it will be quoted as Prime + x%. If you have a really good credit score and large down payment, that additional x% will be smaller as compared to riskier customers.

## Prime Rates Impact on Mortgages and Home Equity Lines of Credit (HELOC)

Prime Rates play a direct role in determining the interest rate you are charged on Adjustable Rate Mortgage (ARM) Loans and HELOCs. ARM loans are variable rate mortgages where the interest rate charged is divided into 2 portions, the index and the margin. The index is usually the Prime Rate whereas the margin stays constant. A Home Equity Line of Credit (HELOC) works in a similar way, except the margin spread is usually higher. If the Fed increases the Fed Funds Rate, the banks will likely increase their Prime Rate, which will increase the interest portion of monthly payments for ARM and HELOC loans.

## Prime Rate and Credit Cards

Credit cards that have a variable interest rate use the Prime Rate as a base for the interest rate charged. Usually banks charge the Prime Rate plus a credit spread, for example if the bank determines your credit spread is 10%, and the Prime Rate today is 3.25%, the total interest charged on outstanding credit balance is 10% + 3.25% which is 13.25%.

The Following graph shows the relationship between the Prime Interest Rate and Commercial Banks Credit Card Interest Rate in the period 1995-2020. The relationship between the two interest rates shows a pattern where the credit card interest rate follows the Prime Rate. During periods of recession when Prime Rates are low, the interest rate on credit cards are also low as the base rate is low. For example, if your credit spread is 10%, if the Prime Rate is as high as 6%, the total interest rate charged is 16% (6% + 10%). In contrast, during periods of recession, if the Prime Lending Rate was 3.25%, the interest rate of your credit card may only be 13.25% (3.25% + 10%). ** The average credit card interest rate as of October 2020 is 14.58%, ** of which the Prime Rate is 3.25% and the credit spread is 11.33%.

## Prime Rates and Auto Loans

Auto loans are taken for the purpose of purchasing a vehicle, similar to other short-term loans the **Prime Rate impacts ** the interest charged on auto loans. An increase in the Prime Rate will result in higher monthly payments on the loan. As of October 2020, **the average auto loan interest rate for new cars is 4.98% and used cars is 9.65%.**

## Prime Rates and Student Loans

Variable interest rate student loans will be affected by the Prime Rate. Variable Rate loans that were previously taken out and loans that will be currently taken will benefit from the lower Prime Interest Rate in the market today. Variable rate student loans have not been offered by the federal government since 2006, whereas private lenders still offer variable rate student loans. Therefore, a majority of college students on fixed rate loans cannot benefit from the low interest rates prevailing in the markets currently.

## Prime Rates from 1980 to 2020

The following chart displays the Fed Funds Rate and the Prime Interest Rate for the last 40 years, giving a good idea of how both interest rates changed in the past.

The formula of ** Prime Rate = Fed Funds Rate + 3% **, can be clearly seen in the graph. The Prime Rate is uniformly above the Fed Funds Rate by about 3% since the 1980’s. The grey areas represent times of** recession **and as in the chart the Prime rate falls in those periods. The reason for this is during recessions, the Fed decreases the Fed Funds Rate resulting in a decreasing Prime Rate. This is done to make it cheaper to borrow money, increase spending as interest rates on savings are very low and increase investments.

## Prime Rate changes in 2020

Due to the economic impacts of COVID-19, 2020 has resulted in two emergency Prime Rate cuts resulting in historical lows since 2008. The Prime Rate Today is 3.25%.

Date | Prime Rate | Change |
---|---|---|

March, 2020 | 3.73 | -1.02 |

April, 2020 | 3.25 | -0.48 |

Prime Rate Today | 3.25 | 0 |

## Prime Rate changes in 2019

In 2019, the year started with Prime Rate at a high of 5.5% since the Housing Market Crash of 2008. However, towards the end of the year the economic expansion predicted was not occurring and the Fed slowly slashed the Fed Funds Rate. Accordingly the Prime Rate also reduced, and by years end it was down to 4.75%.

Date | Prime Rate | Change |
---|---|---|

January, 2019 | 5.50 | 0 |

August, 2019 | 5.25 | -0.25 |

September, 2019 | 5.15 | -0.10 |

October, 2019 | 4.99 | -0.16 |

November, 2019 | 4.75 | -0.24 |

December, 2019 | 4.75 | 0 |

## Prime Rate changes in 2018

2018 saw several rate hikes through the year as the Fed reached its target inflation rate of 2% and expected steady growth in the future. Sustained economic expansion and strong labour market conditions resulted in the Prime Rate increasing to 5.35% by year's end.

Date | Prime Rate | Change |
---|---|---|

January, 2018 | 4.5 | 0 |

March, 2018 | 4.58 | +0.08 |

April, 2018 | 4.75 | +0.17 |

June, 2018 | 4.89 | +0.14 |

July, 2018 | 5.00 | +0.11 |

September, 2018 | 5.03 | +0.03 |

October, 2018 | 5.25 | +0.22 |

December, 2018 | 5.35 | +0.10 |

## Prime Rate changes in 2017

In 2017, the Fed further increased the Fed Funds Rate as employment and growth in the economy was improving. This led to the increase in the Prime Rate, by years end it was 4.4%.

Date | Prime Rate | Change |
---|---|---|

January, 2017 | 3.75 | 0 |

March, 2017 | 3.88 | +0.13 |

April, 2017 | 4.00 | +0.12 |

June, 2017 | 4.13 | +0.13 |

July, 2017 | 4.25 | +0.12 |

December, 2017 | 4.40 | +0.15 |

## Prime Rate changes in 2016

2016 was the first year after the Housing Market Crash that saw a rate increase to 3.5%, at years end the Prime Rate was 3.64%

Date | Prime Rate | Change |
---|---|---|

January, 2016 | 3.5 | 0 |

December, 2016 | 3.64 | +0.14 |

## Prime Rate between 2008 - 2017

Following the Global Financial Crisis or Housing Market Crash of 2008, Prime Rates on average stayed consistently at ** 3.25%, ** in order to increase spending and investments to boost the economy.