Prime Rate.
In plain English
The prime rate is a benchmark interest rate that commercial banks publish for their lowest-risk borrowers, usually large, reliable companies. In practice nearly all U.S. banks set it at a fixed margin above the federal funds rate, the short-term rate the Federal Reserve controls. The common rule is prime equals the top of the Fed's target range plus 3 percentage points. Many consumer loans, especially variable-rate credit cards and home equity lines of credit, are priced as "prime plus" some markup, so when the Fed moves, prime moves the same day and your interest cost follows.
01Why it matters
If you carry a credit card balance or a home equity line, a rise in the prime rate raises your interest charges almost immediately, costing you more each month without you doing anything.
02The math, step by step
Say your credit card is priced at prime plus 12 percent. If the prime rate is 8 percent, your card charges 20 percent. If the Fed raises rates and prime climbs to 8.5 percent, your card jumps to 20.5 percent, and a $5,000 balance now costs you about $25 more in interest over a year. For the current prime rate, see federalreserve.gov H.15.
03What this is NOT
The prime rate is not the federal funds rate the Fed sets directly. Each bank sets its own prime, but in practice it sits a margin (commonly 3 percentage points) above the fed funds target. The Fed moves the funds rate, and banks move prime in step.
04Receipts
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