How Does the Prime Rate Affect Homebuyers?

Dated: July 6 2023

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If you're shopping for a new house or considering investing in real estate, you might have encountered the term prime rate. The prime rate impacts current mortgage rates and loans, and at its core, it's equal to the best interest rate at any given lender or financial institution that will be offered to the most creditworthy clients.

Basics of the Prime Rate

The prime rate is the mortgage rate that's the best possible that a lender will offer a borrower for any amount of money.

That said, the prime rate is typically unavailable to the everyday buyer or consumer.

Shifting the prime rates can also pressure interest rates charged on mortgages and other financial products like credit cards.

Usually, only corporations and institutions are actually eligible for the prime rate because they're seen as the lowest-risk clients for a financial lender.

The Federal Open Market Committee's federal funds rate determines the prime lending rate. The Fed funds rate is the rank banks use to lend money to each other, also known as the overnight rate.

A bank will typically use a combination of the federal funds rate plus three for determining the prime interest rate.

Applications of the Prime Interest Rate

While you might not get the prime rate, it's a benchmark for lenders. It's often described as an underlying index used to determine consumer rates and the costs of borrowing money through credit cards, mortgages, home equity loans, lines of credit, and more. If you apply for a financial product, the current prime rate will ultimately affect your rate.

It's like a starting point for lenders to set their rates and decide on the profit margin they'd like to see.

Another relevant term here is the mortgage margin in real estate. It's the difference between the index, the prime rate in this situation, and the interest rate charged on a loan. It's a percentage of the difference the lender charges for whatever they lend.

The rates are noted as the annual percentage rate (APR).

If you have an excellent credit history and score, your rate might be the prime plus 9% for a credit card. For example, if you had a lower score, it could be prime plus 15%.

Because the prime rate is used as a baseline by most banks, increases or decreases will lead to a fluctuation in adjustable-rate mortgage payments and new loan applications are also affected.

As of May 2023, the prime rate is 8.25%. It went up from the March rate of 8.00% to the February rate of 7.75%.

Throughout 2020 it was between 3-4%, and in 2022 it varied greatly. Early in 2022,  it was around 3.5%, and by the end of the year, it went up to 7.50%.

Overall, the prime rate has been increasing since May 2022, around the same time the Fed started increasing interest rates to combat soaring inflation.

Institutions aren't required to raise prime rates following the actions of the Fed, but most banks and financial services providers note Fed changes and use them to justify their prime rates.

Along with changing based on the federal funds rate, other factors like loan demand and inflation can lead to changes in the prime rate.

As well as affecting an adjustable-rate mortgage, your interest rate could be based on your prime rate if you already have an existing home equity loan or line of credit. If the prime rate goes up, you might see increases in these loans' interest rates.

Unrelated to mortgages, if you have a credit card with a variable interest rate, it might be based on the prime rate. If the prime rate increases, your credit card interest rate may too. Fixed-rate loans or lines of credit aren't impacted if there's a change in the prime rate.

There's no limit on how much prime rates can rise, and while it can adjust at any time, it's usually only going to shift in any significant way when a benchmark is adjusted.

To sum up, a prime rate is geared toward corporate clients, but when it comes to real estate, it's like a barometer of what you might expect on mortgage interest rates and payments.

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Cindy Banks

Cindy Banks has ranked in the TOP 20 for RE/MAX of Northern Illinois from 1996-Present. Cindy sells in both DuPage and Kane counties. She has been licensed for over 25+ years and works full time. C....

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