The Fed What is the prime rate, and does the Federal Reserve set the prime rate?

A rising prime rate means it costs banks more to borrow money, so the prime rate can influence mortgage and auto loan rates. In fact, the surge in the prime rate in 2022 and 2023 was a major catalyst for mortgage rates rising to multidecade highs. If you’re an individual with average credit, your credit card may charge prime plus, say, six percentage points. So, our hypothetical customer is paying 10.5% on their revolving credit line. If the Federal Open Market Committee lowers the rate, the customer will enjoy lower borrowing costs almost immediately.

1. The prime rate can affect many variable-rate loans and lines of credit.
2. If the Fed wants to increase the rate, it could do the opposite by going into the open market and selling government securities.
3. However, that was a September FOMC forecast, and economic data has been somewhat supportive of incrementally higher rates since then.
4. The prime rate can impact rates on personal loans, small business loans, credit cards, mortgages, and more.
5. This shift in preference can lower stock market activity and increase demand for fixed-income investments.

In this article, we’ll discuss the prime rate and why it should matter to you. Founded in 1993, The Motley Fool is a financial services company dedicated to making the world smarter, happier, and richer. As the crisis unfolded, many hesitated to lend or feared that other banks wouldn’t be able to pay back their obligations. The following chart shows the funds rate, prime rate, and one-month LIBOR over a 10-year period. The financial upheaval of 2008 led to an unusual divergence between LIBOR and the funds rate.

How Does the Prime Rate Affect Borrowers?

On its most technical basis, the fed funds rate filters out through the rest of the economy because it’s the interest rate that banks charge each other for overnight lending. Instead, the prime closely follows the federal funds rate that the Federal Reserve sets. As of November 7, 2024, the federal funds rate is 4.75%, with the federal fund target rate being 4.50% to 4.75%. The Federal Open Market Committee recalculates this rate eight times yearly (roughly every six weeks) based on market conditions.

Bankrate logo

During times of economic growth, the prime rate tends to be higher, while it tends to be lower during times of recession or financial turmoil. Markets tend to react negatively to rate hikes, as higher borrowing costs can reduce corporate profits and make investors wary. Unemployment trends in 2025 will likely prove decisive for FOMC policy actions.

If you happened to have a loan indexed to LIBOR, the effect was sizable. For instance, a homeowner with an adjustable-rate mortgage that reset during late 2008 may have seen their effective interest rate jump more than a full percentage point overnight. When you read headlines saying the Fed has raised, lowered or maintained interest rates, they’re referencing the Fed’s decision to adjust its key fed funds rate. Here’s what the fed funds rate is, how it works and how it can ultimately end up impacting your finances — whether you’re a saver or a borrower.

RELATED DATA AND CONTENT

The prime rate serves as an index banks and credit unions use to set rates on consumer loan products. Banks set their own prime rates so what you see reported publicly is an average of some of the largest banks, often surveyed by the Wall Street Journal. After the most recent Fed meeting saw a 0.25% drop in the federal funds rate, the average prime rate fell to 7.75% from 8%, where it had been asset pricing and portfolio choice theory since September 2024. The banks with ample cash then lend to the banks that require the cash. Of course, since no one wants to just lend freely, it comes with an interest rate.

As of April 30, the top-yielding online savings account was offering 5.55 percent a year How to buy atm in interest, up from 0.55 percent at the beginning of 2022, Bankrate data shows. It can also help Americans grow their emergency fund even quicker, a pile of cash that might be crucial given the risks that the Fed may slow the economy too much. In a historic reversal of the low-rate era, Fed officials in March 2022 began raising interest rates by the fastest pace since the 1980s to control post-pandemic inflation.

But the prime rate is only one factor among several that determine how much you’ll pay for loans. Banks also take into account your creditworthiness—the more likely you are to pay them back, the lower the animal spirits rate they would charge and vice versa. The goal of the Federal Reserve is to encourage or discourage borrowing by businesses and consumers. The prime rate increased since May 2022, moving in tandem with the FOMC’s increases to the fed funds rate to combat high inflation. The rate that an individual or business receives varies depending on the borrower’s credit history and other financial details. These rates are normally defined as an annual percentage rate (APR).

They add a margin on top of the prime rate to determine a loan’s interest rate. This cost of borrowing money can be important to both your personal finances and evaluating a company. Changing the required reserve percentage has a similar effect but is seldom used. Reducing the required reserve percentage increases excess reserves and cash in the system. The opposite is true when increasing the required reserve percentage.