Credit Cards and the Prime Rate
The Prime Rate is the one term that is present in the user agreement of nearly every credit card offer on the market. When citing the interest rate, a bank will typically specify a variable rate equal to the Prime Rate plus a fixed percentage. As simple as that sounds, many credit card users don’t know what the Prime Rate is, where it comes from, and why it is important to them.
What Is The Prime Rate
The Prime Rate, otherwise known as the Prime Lending Rate, is an interest rate used as a reference by banks. The term traditionally referred to the interest rate given to their best customers. The Prime Rate can vary from country to country, but in the United States, it is three percentage points above the Federal Funds rate, the rate at which banks will loan each other money overnight. The Federal Funds rate has been .25% since January of 2009 until the time of this writing, making the current Prime Rate 3.25% for the last several years.
Where Does The Prime Rate Come From?
As we have seen, the Prime Rate is a derivation of the Federal Funds rate, which is set by the Federal Reserve’s Open Market Committee that normally meets eight times a year. Should the Fed choose to change that rate, banks would then adjust their Prime Rate. Since different banks can choose different figures for their Prime Rate, institutions must look to a single source as a universal reference. It is customary that banks will use the rate published in the Wall Street Journal as the Journal’s published rate reflects that of seven of the top ten banks in the United States.
Why This Is Important To Credit Card Users
Those who carry a balance receive a standard interest rate that varies based on the Prime Rate. If the Federal Funds rate is at only .25% and the Prime Rate is at 3.25%, it is foreseeable that their interest rate will rise in the future. Judging by history, the Prime Rate has been as high as 20% in the early 80’s and 8% as recently as 2007. Therefore, credit card users who carry a balance must consider the possibility that their interest rates could be as much as 5% higher if the Prime Rate was to return to 2007 levels.
Credit card interest rates are not set arbitrarily; they are tied to a key figure in our economy. By understanding what the Prime Rate is, and how it affects credit card interest rates, cardholders can make the best decisions when it comes to managing their personal finances.
