What is the Prime Rate?
- The prime interest rate, prime lending rate, or prime overdraft rate, is a reference interest rate commercial banks use when issuing variable interest rate loans to their customers.
- Prime interest rate
When you borrow money from a bank, the interest rate that you will be charged by the bank, is usually specified in terms of the prime interest rate.
E.g., if you buy a car on credit, your loan agreement may specify that you will be charged an interest rate of “prime plus one”. This means that while have you the loan, you will be charged an interest rate equal to the prime interest rate at that time, plus 1%.
The prime interest rate can go up and down over time, usually in correlation with the repo rate. When the prime rate changes, the interest rate banks charge on loans to their clients also change (except for fixed interest rate loans).
When granting higher risk loans, a bank will charge a higher interest rate (e.g. prime plus three), while for lower risk loans the bank will charge a lower interest rate (e.g. prime minus two).
Historically the prime interest rate was the rate of interest at which banks lent to favored (low risk) customers, i.e., those with high credibility. However, this is no longer the case, since it is now possible to get loans from banks at below the prime interest rate.