What Is The Prime Rate And How Does It Work?

Whether you’re shopping for a new home or you’re interested in making a real estate investment, you’ve probably heard the term “prime rate” thrown around.

The prime rate impacts loan and mortgage rates. It’s the best interest rate a financial institution can offer its most creditworthy and trusted clients.

Prime Rate Definition

The prime rate is the interest rate financial institutions offer their most creditworthy customers on credit accounts and loans. It’s typically extended to individuals and large corporations and institutions with the highest credit ratings, given the lower risk of default they present.

The prime rate also serves as a benchmark for loan interest rates, including mortgage rates, credit cards and other financial products.

How Is The Prime Interest Rate Used?

The prime rate is a critical financial benchmark. Lending institutions use it to set consumer interest rates and the cost of various consumer products, including credit cards, lines of credit, auto loans and mortgages.

Lenders use the prime rate as a baseline. They add a margin on top of the prime rate to determine a loan’s interest rate.

In real estate, the mortgage margin represents the difference between the index, or prime rate, and the interest rate offered on a loan – the added margin is the lender’s profit for issuing a loan.

Today’s Prime Mortgage Rates

The prime rate often hovers around 3% above the federal funds rate. Beginning March 2022, the Federal Reserve raised the previous target range (0% – 0.25%) to 5.50% in a series of 11 consecutive Fed rate hikes. The increase in interest rates had pushed the prime rate up as well.

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 since September 2024.

Historical Prime Rates

Looking at historical prime rates over time can help provide a sense of where current credit and loan interest rates sit by comparison and how they may change depending on shifting economic climates.

Historical mortgage rates tend to wax and wane based on multiple factors, from inflation and recessions to economic growth and a boom or decline in housing markets. Even changes in oil prices can affect rates. Do yourself a favor and keep an eye on fluctuating prime rates because they can significantly impact mortgage interest rates.

What Determines The Prime Rate?

The Federal Reserve sets the federal funds rate. While the federal funds rate significantly influences the prime rate, the largest U.S. banking and financial institutions determine the prime rate.

Banking institutions consider several factors when setting the prime rate, including the health of the economy and the federal funds rate (the interest rate commercial banks charge each other to lend money overnight).

The Wall Street Journal (WSJ) Prime Rate is the main publishing source of the prime rate. The WSJ surveys large banks and institutions to determine what rates they offer their most creditworthy customers.

Prime Rate Vs. Fed Funds Vs. LIBOR Vs. SOFR

Short for London Interbank Offered Rate, LIBOR was a commonly used interest rate benchmark for major global banks. It phased out in 2023, and the Secured Overnight Financing Rate (SOFR) replaced it in the U.S.

While global leaders discuss interest rate predictions, the federal funds rate should better predict future prime rate adjustments.

Why The Prime Lending Rate Matters For Your Mortgage

The prime rate is a baseline for lenders to determine interest rates on mortgages, personal loans, credit cards and other financial products – it’s not the final rate you’ll pay. The interest your lender charges will likely be higher than the prime rate.

The prime rate significantly influences interest rates and APRs, which ultimately determine the size of your monthly payments – but it’s not the only factor a lender will consider.

APRs on many credit cards (which can fluctuate along with the prime rate) can top 15% – 20%. Individual financial institutions set their rates, which are also influenced by your credit history and credit score.

Of course, the prime rate exerts considerable influence over real estate loan products, especially products with variable interest rates, such as adjustable-rate mortgages (ARMs). When the prime rate climbs, your interest rate may rise and lead to higher monthly mortgage payments.

Common loan products impacted by prime rate adjustments include:

• Certain refinances
• Home equity lines of credit (HELOC)
• Bridge loans
• Federal Housing Administration (FHA) 203(k) loans

If a loan has a fixed interest rate, changes in the prime rate typically won’t have any effect because the rate is locked in for the life of the loan.

Prime Interest Rate FAQs

Below are a few frequently asked questions about prime rate.

Is there a limit on how high the prime rate can go?

To put it simply, no. There’s no limit on how high the prime interest rate can rise. If the Federal Reserve deems it necessary to raise the federal funds rate – indirectly raising the prime rate, it can.

How often does the prime rate change?

While the prime rate can adjust at any time, it typically only sees major adjustments when a benchmark, like the federal funds rate, changes. Severe economic downturns, such as the global recession during COVID-19, are often a major predictor of when the prime rate will drastically change. While the prime rate can technically change at any time, it’s not uncommon for years to pass without a significant adjustment.

Can the prime rate affect your mortgage payments?

Whether the prime rate affects your mortgage payments will depend on the mortgage you have. If you have a fixed-rate mortgage, it won’t be directly affected by the prime rate because you locked in the interest rate for the life of the loan. If you have a variable interest rate loan, like an adjustable-rate mortgage (ARM), your monthly payments will likely go up as the prime rate increases or adjust downwards as the prime rate drops.

A drastic drop in the prime rate may be a reason to explore refinancing your mortgage. Refinancing may lower your interest rate and your monthly mortgage payment.

What’s not impacted by prime rate changes?

The prime doesn’t directly affect all financial products. Fixed-rate loans, such as student loans and fixed-rate mortgages, aren’t directly impacted by changes in the prime rate. And the interest rates on savings accounts aren’t directly influenced by the prime rate either.

The Bottom Line

Lenders typically offer interest rates based on the prime rate and a margin that reflects a borrower’s creditworthiness. With a high credit score, you’ll likely secure a favorable mortgage rate, which may earn you significant savings.

Considering refinancing or buying a house? Start on an application today to see what you may qualify for!