How are the "fed" and Prime Rate related?

Discussion in 'Community Board' started by Free4Life11, Sep 19, 2007.

  1. Free4Life11

    Free4Life11 DIS Cast Member<br><font color=red>I just have to

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    The "fed" just dropped the interest rate by .5% down to 4.75, so how will this effect the prime rate.

    My understanding is that the Prime Rate is equal to the "Fed" rate + 3%, is this correct? I know the Prime Rate we use at work is 8.25%.
     
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  3. NewJersey

    NewJersey DIS Veteran

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    The fed funds rate is the interest rate that banks charge to each other for overnight loans made to fulfill reserve funding requirements. And you are right when you say the prime rate is the fed funds rate plus 300 basis points (3%). The prime rate is the rate that banks lend to their most credit-worthy/favorable customers. So in essence they are making 3% on the money they loan to Customer A that they loaned from Bank A, if that makes sense.
     
  4. debbi801

    debbi801 DIS Veteran

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    Does the prime rate automatically go down when the fed funds rate goes down? :confused3
     
  5. NewJersey

    NewJersey DIS Veteran

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    Not sure if automatically is the right word, but yes it goes down since its cheaper for the banks to loan money from other banks, so in essence the banks will charge the consumer less interest to borrow money.

    Also, you might notice your interest rate on your credit cards might fall as well, since many cards have interest calculated based on the prime rate plus some sort of spread.

    http://money.cnn.com/news/newsfeeds/articles/apwire/D8ROIVSO0.htm

     
  6. wnissen

    wnissen Mouseketeer

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    That is correct, it is not automatic but in general you will see a cut in the Fed interbank rate ("the" rate) reflected pretty quickly due to competitive pressures.

    Then, you'll see the change in the prime rate reflected in your home equity loans as they adjust, monthly or yearly. Most adjustible-rate mortgages do not follow the prime rate, but rather the LIBOR, the London Interbank rate, which for various reasons is behaving oddly lately.

    The funny thing about rate cuts is that the average American is a net creditor. They are hurt by lower interest rates.

    Walt
     

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