You probably hear the term “Prime Rate” whenever you hear anything about the Fed raising or lowering rates. I work at a bank, and whenever the Fed raises rates at their meeting, my company will send out an email the next day that says the Prime Rate rose by the same amount. Is Prime Rate the same thing as the Fed rate? No, and I’ll explain the difference.
Whenever the Fed changes the “rate,” what they are changing is the Fed Funds Rate. This is the rate that they charge banks to borrow money from them. Yes, this does happen. This rate is always expressed as a range. As of this writing, the Fed Funds Rate is 5.25-5.5%. That rate has changed a LOT in the last 18 months. It never stays constant for long.
The Prime Rate is connected to the Fed Funds Rate, but not directly. It’s in a kinda-sorta type of way. The Prime Rate is the rate banks charge their best customers to lend money. It is a fixed rate, and it’s determined by the banks. As of this writing, the Prime Rate is 8.5%. You’ll notice it’s about 3 points higher than the Fed Funds Rate, and that is consistent. Most banks will use the Wall Street Journal Prime, or WSJ Prime Rate, to set their own prime rate. So, while the Fed is not changing the prime rate, whenever they change their own rate, the prime rate changes with it, but only because that’s what the banks decided to do, not the Fed. In summary, the Fed is not changing the prime rate, but the prime rate is guaranteed to change when the Fed changes the Fed rate.
Prime rate is what your lender is referring to when they set the terms for a line of credit. Your approval rate may be something like, Prime + 1%. That simply means that they are adding 1% to whatever the prime rate is. That protects the lender from giving you a fixed 4% rate on a line of credit and then it jumps to 10% in 18 months. Your fixed term loans don’t change when Prime changes. So, that mortgage or auto loan you took out 3 years ago is still a contractual guarantee, regardless of what prime does.
Prime rate has nothing to do with any type of savings accounts. While your APY does tend to go up when the Fed Funds rate increases, it isn’t at the same frequency or amount. That rate is set by competition. One institution may be cash-heavy and offer 1% on a CD, while another institution is trying to raise cash and starts paying 4% to try and entice people to move money. That is completely different that the prime or fed funds rate.
