The Prime Rate - A Key Interest Rate

The Prime Rate is a critical interest rate to both world financial markets and consumer loan products however the prime rate which many consumers think they know is often confused with what is actually the the federal funds rate.  Its very common to believe your interest rate on a home loan will change when the Federal Reserve announces lower interest rate however the Federal Reserve really only plays the beginning role in determining the prime rate as consumers know it.

First, lets explain how we get to the prime rate (as the general public understands it).  The committee responsible for changing interest rates is part of the Federal Reserve known as the FOMC.

FOMC in an acronym for the "Federal Open Market Committee" and this commitee holds (at this point in time) eight (8) regularly scheduled meetings per year. It is this federal committe's responsibility to  review current economic and financial conditions, determine an appropriate stance of monetary policy and assesses the risks to its long-run goals of price stability and sustainable economic growth for the economy.

If the FED decides to lower interest rates many consumers  believe they are in fact lowering the prime rate.  Not always true however this does play a big role (possily the biggest) in staging the downward movement in the prime rate over the days to come.

The prime rate consumers most hear (and the one noted in your loan document) is most likekly the prime rate as published by the Wall Street Journal® – also known as the WSJ prime rate.

The prime rate posted by banks averages around 3 percent over the federal funds rate. So, when the Federal Reserve announces a rate change it’s really to the interest rate banks pay to loan from each other - a consumers rate will be around 3% higher.

Common Question – The Fed lowered interest rates but the prime rate DID NOT move. Why?

Remember, as a guideline the prime rate is 3% greater than the federal funds rate but its up to the banks to change their posted rates and once 75% of banks introduce new rates then – and only then - will you see a change to the WSJ Prime Rate.

Probably the easiest definition for understand the movement of the Wall Street Journal’s prime rate is defined as:

” When 23 out of 30 of the United States’ largest banks change their prime rate, the Wall Street Journal then prints a prime rate change ”

Although many interest rates such as the LIBOR index can change daily the prime rate moves less often and is one of the most stable financial values for the global economy.