Almost all of us hear some variation of this from our credit card or car loan company: your interest rate is a variable rate of 14.99% based on Prime plus 6.74%. That means your current rate is 14.99% but may change at any time, so if the prime interest rate goes up or down 0.5% so will your card. Let’s look at the Prime rate closer, and I’ll share some tips to enhance your credit search.
The Prime Interest Rate, also known as the Wall Street Journal Prime Rate, is based on a survey of lenders by the WSJ. This is the rate that lenders offer to their most premium borrowers. The additional interest that your lender tacks on your loan, called the spread or margin, will decrease as your creditworthiness increases.
Better Credit; Lower Spread. Many of us start out with credit cards in college with rates running into the high teens or low twenties — analogous to a 10-12% spread. However, as you get older and build your credit, your spread will decrease. For example, I recently received an unsecured line of credit from CitiBank with a spread of 0.99%. The idea being that as your creditworthiness increases, your risk decreases, so a lower interest rate is required.
Comparison Shopping: Apples to Apples. It’s more important to find a low spread than it is to find a low interest rate. Because prime can change frequently, look for the spread on that credit card you’ve been eyeing. If you found a card with an 11.99% interest rate two months ago, and you just found another card with an 11.99% interest rate today, the new card may be more costly if interest rates fell 0.50% within the last two months. Always be sure to compare apples to apples by comparing the spread.
About Fed Rates
Just like credit card rates are based on the Prime Rate, the Prime Rate is based on the Fed Discount Rate and Fed Funds Rate.
- The Fed Discount Rate is what the Federal Reserve loans money to banks at.
- The Fed Funds Rate is based on the Fed Discount Rate and is the Fed’s target of what they would like banks to loan money to each other at.
Because banks and credit card companies borrow money at these rates to provide loans and credit to their customers, some if not all of the cost is passed on to the consumer through the Prime Rate. So when you hear that the Fed is raising or lowering interest rates, look for a change in your Prime Rate coming to a statement near you.
You can find all the current Prime and Fed rates at BankRate.
The Federal Reserve: Monetary Policy. Investopedia.
Credit Card Management: Basics of Card Rates. AOL Money & Finance.