What is the Prime Rate? — The Prime rate is a benchmark rate used to determine how much interest financial institutions charge on credit borrowed to consumers.
Who is responsible for adjusting the prime rate? — The prime rate is set by the Federal Reserve.
How It Affects Finance? — Prime rate affects our finance in a number of ways.
The prime rate is always seen as the first approach to controlling a recession. Burst periods which accompany the end of a market boom can be controlled by reducing the prime rate. Up until now, the Federal Reserve has steadily reduced prime rates in a bid to reduce interest rates and stimulate consumer spending. Some economists still believe the Federal Reserve did little to prevent the financial crisis starting in 2008, as the downward review of prime rates at a precise time would have done much to stimulate consumer spending and inter-bank lending prior to its coming to a free fall. This thesis is strongly disputed as untrue by the opposing side who think it’s impractical to have known the exact rate and timing that would have averted the crisis.
Whichever be the case, prime rates have been used to fight against this crisis until December 2008, when the rate was reduced to 0.0% For now nobody can be sure if a negative rate would be used.
Debt consolidation is often made easier when the rate undergoes a downward trend. In opposite terms, it becomes harder for consumers having larger debt to pay off such debts when the rates experience an upward trend. This is so as a result of banks and other lending institutions tagging their interest rates to the prime rate. Interest rates are usually not the exact prime rate but a few percentages above it.
Consumers are at the mercy of the prime rate since they have to reconsider and adjust any debt repayment strategies they may have in place.
Credit cards are very much tied to the Prime Rates. Most credit card issuers have a policy with regards to how the prime rates affects interest rate charged. Interest rates charged on these cards are usually reviewed quarterly so consumers don’t really feel the impact immediately. Additionally, card issuers often choose to bench interest rates on the highest prevailing prime rate throughout the previous 90 days or other fixed number of days.
Student loans especially those from private sources are hinged on the prime rate. Consumers on student loans incur interest rates that are dependent on the prevailing prime rate. The higher the prime rate, the higher the interest rate charged. This is same when rates enjoy a downward review.
Adjustable Rate Mortgages (ARM)
Adjustable Rate Mortgages often charge a fixed interest rate over a certain period. When this period expires, the ARM is adjusted according to short-term indexes that are affected by movements in the prime rate. ARMs have the disadvantage of uncertainty, making it more difficult for the borrower to plan ahead and ascertain just how much is needed to meet loan requirements (minimum payments) in the long run.
Home Equity Lines of Credit
Like all other forms of credit listed above, home equity loans are also affected by changes to the prime rate. Banks and other financial institutions providing such loans based their rates on the prime rate.
The banking industry has changed since the good old days when the prime rate was actually how much banks lent money to customers, this is no longer the case. Virtually every child and adult consumer in the U.S. is affected by a reduction or increment in prime rates. For some, the effects of a change are immediate while others may not feel it until rates are reviewed.