How Prime Lending Rate Affects Your Personal Finance

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Money, credit cards and Prime Lending Rate (PLR)

Source: web

What Is The PLR?

The prime lending rate (PLR) or the Prime Interest Rate is the reference interest rate, which commercial banks make use of, when they issue variable interest rates to their customers. In other words, it is the basis that most banks use to set interest rates on different short-term loans that they issue, including credit cards.

The formula for calculating the Prime Interest Rate is the Federal Fund Target Rate + 3. So, if the FFT is 0.25, then the prime lending rate is 3.25 percent. Most credit cards have a variable interest rate, which implies that the interest rate charged fluctuates in according with the prime rate. In such cases the credit card agreement has a specified margin of a certain percentage above the particular rate. For instance, if the prime rate is 3.25 percent, the average variable interest rate on a credit card is 14.78 percent. This means the customer has to pay the interest rate of prime plus 11.53 percent.

The prime lending rate can move up and down in tandem with the federal funds rate, which is the interest rate at which commercial banks can borrow from the Federal Reserve System. These banks can only make a profit if they lend money to their own customers at a higher rate. When the federal fund rate changes, it can affect the prime lending rate. This in turn affects the interest rate the commercial banks charge their customers.

The Changing Perception Of The Prime Lending Rate

Before the 80s, the prime rate was often associated with the interest rate offered to a bank’s credit-worthy customers. Now, it is indicative of an “index” or a base upon which other interest rates are calculated, rather than the actual borrowing rate. Most consumer loans such as credit cards, automobile and equity loans, and other forms of short-term debt, have a direct correlation to the prime rate.

The Wall Street Prime Journal prime rate quotes are the most referenced ones because it publishes a combined rate of about 75 percent of the most influential banks in the U.S. The Federal Open Market Committee meets eight times annually to set the federal funds rate. If there is a need to stimulate the economy, this committee lowers the rate to promote lending. If there is rising inflation, the FOMC increases the rate to discourage lending.

How Can Prime Lending Rate Affect You?

The current Wall Street prime lending rate is 3.25 percent. Banks set the prime rate to set rates for consumer loans and credit cards. Let us assume the interest rate on your variable credit card is 14.25 percent (3.25 percent prime + 11 percent). If you have an outstanding balance of $5,000, you are paying $700 in interest every month. If the prime rate increases to 8 percent, then your APR can increase to 19 percent (8 percent + 11 percent). Now your interest payment every month will rise to a formidable $950.

Card users are prone to being swept into a potentially debt-ridden situation with high monthly bills, late fees, and heavy finance charges. In fact, just a fractional rise in the Annual Percentage Rate (APR) can translate into a substantially high outstanding balance. Due to high rates, credit card users exceed their credit limit, which means more penalties, including over-the-limit fees. In case of a default, the interest rate increases further, pulling the consumer into a debt trap.

Do Card Companies Notify About Interest Rate Changes?

If you read the fine print of a credit card agreement, it says that credit card companies are not required to inform customers about prime lending rate movements and the subsequent interest rate changes because these changes can take place on a regular basis. But the credit card company has to give cardholders at least 45 days prior notice if the bank decides to change the difference between the prime rate and the interest rate credit cardholders have to pay.

It is seen that the interest rate charged by card companies for a variable credit card is between a rate floor and a rate cap. The “rate floor” is the base rate below which the card issuer never reduces the interest rate, even if the prime interest rate movements may cause the rate to fall below this level. The rate cap is the rate above which the card issuer will never increase the rate, even if the prime exceeds this point.

Rate floors are usually set between 3% and 5% while caps are affixed at 30%.

Can The Prime Lending Rate Affect Your Mortgage?

The prime rate affects short-term loans that are for a period of 10 years or less. Mortgage rates apply to long-term borrowing commitments which span from 15 to 30 years. Unless, there is something drastic in the economy which can impact the real estate industry, mortgage rates are usually stable. However, in inflationary periods or when there is a major economic crisis, mortgage rates can also vary on a daily basis.

Can You Control Your Finance And Credit By Following PLR?

Most credit products have their interest rate tied to the prime rate. Since the prime rate characteristically moves in accordance with the Federal Reserve Board’s adjustment of the federal funds rate, it is important to keep a tab on the Fed meeting, which is usually every six weeks. You can also check the details of the changes on short-term borrowing at the fed prime website, where it lists the dates of such meetings.

You should select a fixed-rate loan when the interest rates are moving up, particularly if you expect an increase of more than a few percentage points in the tenure of your loan. Fixed rates pertain to those loans in which both the principal and interest does not change in the course of the entire life of the loan. Most home and auto loans fall under the fixed rate interest category. You should choose an adjustable-rate mortgage when interest rates are falling. You will also inherent the benefit of a lower initial interest rate compared to the fixed loan.

There are very few fixed-rate credit cards and the ones that are available, carry high interest rates. But you will be able to manage your budget better with these because there is no fear or risk of an increase in the interest rate in the future. Since you are in the know of how much you owe each month, it is easier for you to manage your budget.

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About Author

Benjamin is from Sacramento, CA. He has 2 master’s degrees and served 4 years in the U.S. Navy. He has worked at Wells Fargo Financial and has been investing in equities since 1995. He is a constant reader of finance articles and books related to business.


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Advertiser Disclosure

CREDIT DAD is an independent, advertising-supported website. Many debit cards, credit cards and other financial offers that appear here are from companies from which CREDIT DAD Websites receive compensation. This compensation may impact how and where products appear on this website (including, for example, the order in which they appear). CREDIT DAD Websites do not include all card offers in the marketplace.