Prime Rate

The Prime Rate term refers to the interest rate that banks charge their most financially sound borrowers (borrowers with excellent credit rating). The phrases Prime Rate and Prime Interest Rate are interchangeable. The prime rate between major banks in one and the same country usually varies very slightly.

The prime interest rate in Canada is usually linked to the Bank of Canada key overnight lending rate. In US the prime rate is linked to the Federal Reserve target key rate. The prime rate is always higher than the official central bank rate. In US the prime rate is usually 3% higher than the official central bank rate.

The Wall Street Journal Prime Rate index is the most popular US Prime rate index. The Wall Street Journal Prime Rate index changes to the base corporate loan rate posted by a minimum of 75% of the 30 top US banks. For example if at least 23 of the 30 major US banks post a base loan rate of 8% at the same time, then the Wall Street Journal Prime Rate becomes 8%.

The main Prime Rate use is in computing interest rate changes for various floating rate loans like personal line of credit, home equity loans, adjustable rate mortgages, credit cards and secured credit cards. Such variable rate loan products have their rate tied to the prime rate. For example a personal line of credit might specify interest equal to the prime rate plus 3% (or other fixed value). If the prime rate increases it gets more expensive for the borrower to borrow on his credit line.

In conclusion the prime rate is an important factor, which determines the interest rates on all floating rate loans and affects the credit demand. Central banks usually lower their target interest rates to avoid economic recession and increase the rates to cool off overheated economies and avoid asset bubbles. This in turn affects the prime rate posted by commercial banks. In a real free market economy there's no need for artificially setting the target lending rate by a central bank, because the prevailing interest rate will be simply set by supply and demand. However the so-called free markets around the world are heavily manipulated by central banks.