What is the prime rate?

The prime rate is the base interest rate that commercial banks charge their most creditworthy corporate customers. In practice, it is set as a fixed spread above the federal funds rate, currently 3 percentage points. When the Fed moves its target rate, the prime rate adjusts by the same amount on the same day.

While few borrowers actually pay the prime rate itself, it serves as a reference rate for a wide range of consumer and business credit products. Credit card interest rates are often expressed as "prime plus X%." Home equity lines of credit (HELOCs), adjustable-rate mortgages, and many small business loans also float off the prime rate. This means that every Fed rate decision directly and immediately affects the interest payments of millions of borrowers.

The prime rate has been remarkably stable relative to the federal funds rate for decades. The convention of a 3-percentage-point spread above the funds rate has held since the early 1990s. Before that, the spread was more variable and banks competed more aggressively on their posted prime rates. Today, major banks all post the same prime rate.

Understanding the prime rate is important for personal financial planning. If you carry a credit card balance, your interest charges are directly linked to the prime rate and thus to Fed policy. When the Fed is in a tightening cycle, credit card APRs rise in lockstep, increasing the cost of revolving debt. Conversely, in easing cycles, variable-rate borrowing becomes cheaper.

For the broader economy, the prime rate is a transmission mechanism that converts abstract monetary policy decisions into tangible borrowing costs for households and businesses. Tracking it helps you understand how Fed policy flows through to the real economy and to your own finances.