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What is prime rate on a loan?
How the Wall Street Journal prime rate can affect the cost of your loan.
The WSJ prime rate for May 2021
- This week: 3.25%
- One month ago: 4.75%
- One year ago: 5.5%
What is the prime rate?
The prime rate is the interest rate that most big US banks give to their most creditworthy borrowers, fluctuates based on the state of the lending market and overall economy. If you have strong credit and overall personal financials, you could qualify for a loan based on the prime rate alone. Otherwise, lenders typically treat the prime rate as what’s known as a benchmark or starting rate on a variable-rate loan.
How does the prime rate work?
Lenders give borrowers a smaller fixed percentage called a margin rate, and then add that number to the ever-changing prime rate. So, if you got a variable-rate loan at 2% margin rate + prime — and the prime rate was 5% — you’d actually pay a 7% interest rate. If the prime rate goes up to 6%, then you’d pay an 8% interest rate.
The prime rate is also called the prime lending rate, WSJ prime rate, the index rate and sometimes even just “prime.” You can learn more about how benchmark and margin rates work by reading our article on fixed-rate and variable-rate student loans.
How is the prime rate calculated?
The Wall Street Journal calculates the prime rate based on the interest that the top 30 largest banks in the country charge their most creditworthy clients. Then it publishes a rate based on the results. The prime rate changes when three-quarters of the banks — or 23 of them — change the most competitive rates they offer.
You can typically get an idea of the prime rate by looking at the federal funds rate, or the interest rate banks charge each other on overnight loans if they don’t have enough cash in their reserve when the day is over. The Federal Reserve sets the federal funds rate to protect against inflation and control economic growth.
The prime rate is typically around 3% higher than the federal funds rate. Currently, the federal funds rate is 0-0.25% and the prime rate is 3.25%.
What loans use the prime rate?
Any variable-rate personal or business loan might use the prime rate as a benchmark. It’s also common with mortgages and other types of home loans. However, not all variable rates are based on the prime rate.
Many lenders that use prime write out the rate as: prime plus the margin rate. Otherwise, a lender might give you a range of current rates and mention what type of benchmark it uses in the fine print.
Private student loans
You might run into the WSJ prime rate if you’re looking for a private student loan or want to refinance your student debt. That’s because most student loan providers offer a choice between fixed and variable rates. However, lenders more commonly use the LIBOR rate on variable-rate student loans, not the prime rate.
Fixed-term business loans and lines of credit often come with variable rates — many of which are based on the prime rate. Unlike with student loans, you typically don’t have a choice between fixed or variable rates. The lender usually offers one or the other. Still, many types of alternative business financing — like invoice factoring — rely on other fee structures that don’t involve interest at all.
Prime rate isn’t as common on general-use personal loans — many lenders only charge fixed rates. You’re more likely to find a variable-rate personal loan based on the WSJ prime rate if you apply for a loan with a big bank — and even then it’s more common with unsecured lines of credit.
Variable rates are even less common with car loans than personal loans, meaning that you probably won’t have to worry about the prime rate when getting your next set of wheels or refinancing. Like with personal loans, variable-rate car loans that rely on the prime rate are more common with big banks than smaller online lenders.
Variable rates are perhaps the most common with home loans. Adjustable-rate mortgages come with a period of fixed interest rates and another with variable rates that might be based on the WSJ prime rate. But it’s more common with home equity loans and lines of credit.
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Understanding the prime rate can give you a better idea of how much a variable-rate loan will cost. Since it changes based on the state of the lending market, you could end up either saving or paying a lot more than you would with a fixed-rate loan.
To learn more about how loans work, read our guide to personal loans.
Frequently asked questions
Answers to commonly asked questions about the WSJ prime rate.
How often does the prime rate change?
The prime rate is subject to change ever six weeks, when the Federal Reserve meets to discuss the federal funds rate. However, it can stay the same for an indefinite period of time.
Are SBA loan rates based on the WSJ prime rate?
Sort of. The Small Business Administration (SBA) bases the maximum interest rate that banks can charge for its popular SBA 7(a) program on the prime rate. However, it can get a lot more complicated with other SBA programs. Read our guide to SBA loans to learn more about how they work.
Are subprime rates higher or lower than the prime rate?
Subprime rates are for borrowers with less-than-stellar credit, so they typically get higher interest rates than the prime rate.
Is the prime rate the same as the fed rate?
No, though the fed rate can influence the prime rate. The fed rate is the interest rate that the Federal Reserve uses when it lends money to banks and other lenders. The fed rate in turn affects the interest rates that lenders offer their prime customers.
The WSJ prime rate is based on the interest rates that these banks are offering. So, typically when the fed rate increases or decreases, so does the prime rate.
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