What is the prime rate and how is it set?

Whether you’re reading the news online or looking at your credit card statement, you might come across the term prime rate. The prime rate can have a direct effect on the interest you pay on credit cards and other loans.

But just what is the prime rate and how might it affect you as a borrower? Here’s what you need to know.

Key takeaways

• The prime rate is the interest rate that most credit card issuers use to set the annual percentage rate (APR) on credit cards.
• The prime rate fluctuates when the Federal Reserve changes the federal funds rate.
• It’s likely that your credit card’s APR will be higher than the prime rate, and it may fluctuate as the prime rate changes.
• Changes to the prime rate may impact things like your credit card minimum payment and interest rate on various financial products.

The prime rate is an interest rate that most commercial banks and other lenders use to set the APR on credit cards, as well as on other types of loans, including mortgages, personal loans and home equity loans. The prime rate determines how much interest you’ll pay on purchases and other transactions made with your credit card. It’s typically based on the current federal funds rate.

It doesn’t necessarily mean your APR will match the prime rate, though. That’s because banks typically use the prime rate as a starting point when setting interest rates for various financial products. Lenders often take a borrower’s creditworthiness into consideration when determining what interest rate they ultimately qualify for.

The prime rate is typically influenced by the federal funds rate, which is the overnight rate that banks use to lend money to each other. Depending on the Federal Reserve’s view of the U.S. economy, the Fed may adjust the federal funds rate, which will likely impact the prime rate. 

The federal funds rate is normally used as the benchmark, or base rate, for prime rates. So when the Fed tweaks the rate, it causes the rate percentage to change. However, those shifts are usually small.

The prime rate can fluctuate based on various factors, such as:

• Inflation
• Current demand for loans
• Federal funds rate

To stay up to date with the current prime rate, visit The Wall Street Journal.

Here’s how the prime rate has changed over the past few years, according to the Federal Reserve of St. Louis:

The prime rate is a baseline banks use for setting APRs. So when it comes to the interest rate or APR on your credit card, your APR may be higher than the prime rate. 

And changes in the prime rate can affect your APR. For instance, if your credit card has a variable APR based on the prime rate and the prime rate goes up, your APR may go up. If the prime rate drops, your APR could follow.

Your current APR can be found on your monthly credit card statement. If you’re a Capital One customer, you can find your current APR—and determine whether it’s based on the prime rate—by looking at the Interest Charge Calculation section of your mailed or online statement.

If you have a variable APR, it’s simply an index rate—usually the prime rate—plus a number, which is called a margin.

If you’re wondering whether prime rate changes impact your credit account, the first step is to check your monthly statement. There, you can see if your APR is based on the prime rate. For Capital One customers, your online statement or the back of your printed statement will also show you when any changes to the prime rate may affect your account.

Yes, it can. Your minimum payment might include interest charges, which are based on your APR. If your APR is affected by a change to the prime rate, your minimum payment may also change.

Most changes to the prime rate will have a pretty small impact on your monthly interest charges. For instance, if you have a balance of $500 and your APR goes up 0.25%, your monthly increase in interest charges would be only about 10 cents. Even if you carry an average daily balance of $10,000, that same rate change would mean your monthly interest charges would increase by about $2.

Because changes to the prime rate can impact interest rates on other loans or financial products, borrowers can be affected in a few different ways depending on debt they have.

If a loan has a variable interest rate, that means it could go up or down based on the prime rate it’s tied to. You might see that with these types of debt:

• Credit cards
• Home equity lines of credit
• Adjustable-rate mortgages
• Auto loans
• Small-business loans

Keep in mind, there are plenty of other factors that can affect the interest on a loan.

The prime rate is based on the federal funds rate and provides a baseline for commercial banks and lenders to set their interest rates. If you have a loan, like a credit card, with a variable interest rate, your interest rate might change based on fluctuations in the prime rate. 

Whether you’re shopping for a new credit card or looking for ways to lower your interest on an existing card, understanding rates and how changes can impact you is a great start. At the end of the day, it can help you be a smarter consumer with better control of your credit. 

Looking for a low-interest card? Check out cards with a low intro APR and see if one is right for you.