Interest rates measure the cost of money: When rates rise, it's more expensive to borrow. Extending credit to customers is a basic engine of economic activity and growth, but all lenders -- banks, credit card companies, mortgage companies and other financial institutions -- need a benchmark index to set the rates they're going to charge. For most, that means consulting the prime rate.
The Prime Rate Survey
Prime rate is a banking term that refers to the interest rate charged by a lender to its most creditworthy customers. A consensus prime rate is published daily by the Wall Street Journal, the nation's leading financial newspaper. The Journal surveys leading banks regularly to inquire about their current prime rate. In most cases, this rate is tied by the banks to the federal funds target rate, set by the Federal Reserve Open Market Committee. The fed funds rate is the interest rate for short-term loans from the Federal Reserve to the banks. As of May 2015, the Federal Reserve had been keeping the target rate at 0.25 percent since December 2008. When the fed funds rate rises, the prime rate rises with it.
Changes in the Prime Rate
The prime rate can change from one week to the next, or it can remain the same for years. It all depends on the target federal funds rate set by the Federal Reserve, which in turn varies with the growth, or lack of growth, in the national economy. In general, low rates stimulate economic activity, while higher rates slow it down and also tend to reduce inflation. Since the cost of money from the Federal Reserve has remained the same since 2008, the prime rate published by the Journal has also held steady. The last change to the rate before May 2015 took place on Dec. 16, 2008, when the prime rate fell from 4 to 3.25 percent. Before that downward adjustment, the rate changed six times in 2008 and three times in 2007, when the country experienced an economic slowdown and recession. The first prime rate ever published was 1.75 percent on Dec. 1, 1947.
Prime Rates and Loans
The all-time highest prime rate was 21.5 percent, reached in December 1980. The prime rate provides a reference for lenders when setting the rates they charge borrowers. In 1980, therefore, it was quite expensive to borrow, while by 2015 it was much cheaper. Credit card companies typically set the interest rate on their accounts at prime plus, meaning a set rate over and above the published prime rate. Mortgages and auto loans also follow the prime rate, although rates on these secured loans are lower than those on credit cards and other unsecured accounts. Interest rates can also vary with local economic conditions, the demand for loans and competition among lenders for business. Variable-rate loans generally follow a different index known as the Cost of Funds Index or COFI.