Prime rate is the interest rate that is charged by lenders to borrowers who they consider most creditworthy. This interest rate varies little among banks. A revision of the prime interest rate is generally made by most banks at the same time, however, this does not happen frequently.
The prime interest rate is generally used as a benchmark to decide other interest rates within the system. It is used in determining the interest rates for mortgages, home equity and other kinds of variable rate loans. In some cases, it is used to decide private student loans also. It is also seen that several credit card companies also charge interest rates that are linked to the prime interest rate.
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Under normal circumstances, the prime interest rate is pegged approximately 3 percent above the federal funds rate, which is the interest rate that banks charge each other for parking short term funds. The federal funds rate is determined by the discount rate, which is the rate that is actually set by the Federal Open Market Committee (FOMC) in its periodic meetings. The Federal Reserve thus manages the federal funds rate. Other rates, including the prime rate, are set using this base rate as a benchmark.
Today the most widely recognized prime rate index is the Wall Street Journal Prime Rate (WSJ Prime Rate), which is published in the Wall Street Journal. The prime rate does not change on a regular basis, which is unlike the other indexed rates; rather, it changes whenever banks need to alter the rates at which borrowers borrow money. It has been observed that when 23 out of 30 of the United States' largest banks change their prime rate, the WSJ prints a composite prime rate change indicating the change in the prime rate for that time period.
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