What is the prime rate and how does it work?

If you’re looking at different loan options, you know that there’s sometimes a lot of vocabulary to think about. Even with interest rates, there are four different benchmarks that are commonly tracked. Many of them are interrelated. If you don’t follow the markets every day, you could be forgiven for being confused.

One of the biggest things to pay attention to is the prime rate, but what is the prime rate? How does it impact mortgage rates, among other loan and credit offerings? Let’s demystify things.

How prime interest rates impact you

The prime interest rate is the rate lenders charge their most creditworthy borrowers. It serves as a baseline for all the other interest rates charged by the financial institution. It’s a barometer that helps them determine interest rates on mortgages, personal loans, credit cards, and any other financial offering they may provide. The interest rates and annual percentage rates (APR) are often based on the bank’s prime rate plus a margin.

Some things are more directly impacted by the prime rate than others. Credit card rates tend to move directly with changes in the prime rate, and the margin can be as high as 15% – 20%, based on your credit history. But even if only exposed to fluctuations in the prime rate indirectly, there’s considerable influence over real estate loan options, particularly if it’s a variable or adjustable-rate mortgage (ARM).

Here’s a list of other common loan types impacted by prime rate adjustments:

• Certain refinances
• Home equity lines of credit (HELOC)
• Bridge loans

Fixed rates aren’t affected by adjustments to the prime rate because they don’t change over the life of the loan.

Today’s prime 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 pushed the prime rate up as well.

Banks set their own prime rates so what you see reported publicly is an average of 70% of the 10 largest U.S. banks, as surveyed by the Wall Street Journal (WSJ). After the most recent Fed meeting saw a 0.25% drop in the federal funds rate, the average prime rate fell to 7.5% from 7.75%, where it had been since November 2024.

Historical prime rates

Like historical mortgage rates, prime rates tend to rise and fall for a variety of reasons, from inflation and recessions to economic growth and an upturn or downturn in housing markets. Even changes in oil prices can affect rates. Keep an eye on changing prime rates as they can greatly impact mortgage interest rates.

What determines the prime rate?

Lenders set their own prime rates. In general, they’re based on the movements of the federal funds rate because this is the cost for federally backed banks to borrow money from each other overnight to fund their short-term operations. If the costs of borrowing for them go up, it’s typically passed on to clients. In setting the rate, the federal funds rate is added to a margin chosen by the lender.

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?

There’s no limit to how high banks can set their prime rate. The only restraint is competition of other lenders.

How often does the prime rate change?

The prime rate typically only changes with fluctuations in the federal funds rate. The Federal Open Market Committee meets to determine the federal funds rate eight times per year, but the rate doesn’t always change.

Can the prime rate affect your mortgage payments?

The prime rate could affect your mortgage payments if you have an ARM tied to your lender’s prime rate.

What’s not impacted by prime rate changes?

If you have a fixed-rate loan of any kind, these won’t be affected by changes in the prime rate. The interest rate is effective for your entire loan term.

The bottom line: Prime interest rates are a baseline

The prime rate is given to a lender’s most creditworthy borrowers. To come to the final interest rate, this is added to a margin based on the type of loan someone is getting and their credit history. Although every loan is impacted in some way or another, the ones that directly change with the rise and fall of the prime rate are short-term revolving credit lines. Fixed-rate loans don’t change for as long as you have them.

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