What is a Prime Rate?

Prime rates explained in simple terms

A prime rate is the interest rate banks the Federal Reserve gives to member banks.

A prime rate is the interest rate banks will charge their “best borrowers”. It is largely dependent on the Federal Funds Rate and the “discount rate” the Federal Reserve gives to its member banks. So if the discount rate goes up, the prime rate also increases. It directly affects home equity loans and HELOCs, and indirectly influences several mortgage rates (such as adjustable rate mortgages or ARM).

Generally speaking, mortgages aren’t directly affected by the prime rate and Fed adjustments. However, if the Federal Reserve is predicting a more robust economy, this usually means more expensive mortgages, especially long-term ones like adjustable rate mortgages. Those with an ARM can expect to pay bigger monthly fees. This also leads to higher property prices. And as a result, homes can become less affordable for most people.

Your home equity line of credit or HELOC is directly influenced by the Fed’s prime rate. So if it spikes, expect your HELOC payments, no matter what rate, to also go up. It usually increases by about the same amount as the growth in the Federal Funds Rate.

When you are faced with increasing prime rates and equity payments, there are several methods to still have control over your loans and finances. For example, you can consider paying down your balance or converting your variable HELOC into a fixed-rate home equity loan.

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