What is the prime interest rate and how does it work?

Whether you’re reading the news online or looking at your credit card statement, you might come across the term “prime rate,” also referred to as the prime interest rate or prime lending rate. In short, the prime rate helps banks and other lenders decide how much interest they want to charge on their financial products, such as loans.

But how is the prime rate determined, and what’s the current prime rate? Here’s what you need to know. 

Key takeaways

• The prime rate is the interest rate that most credit card issuers use to set the annual percentage rate (APR) on credit cards.

• The prime rate fluctuates when the Federal Reserve, the central bank of the U.S., changes the federal funds rate.

• Your credit card’s APR will likely be higher than the prime rate and may fluctuate as the prime rate changes.

• Changes to the prime rate may affect your credit card minimum payment and interest rates on other financial products.

The current U.S. prime rate is 8.50%, having risen from 8.25% on July 27, 2023. To stay up to date with the current prime rate, visit The Wall Street Journal (WSJ).

The prime rate is an interest rate that most commercial banks and other lenders use to set the annual percentage rate (APR) on credit cards, mortgages, personal loans, car loans and more. When it comes to credit cards, the prime rate determines how much interest you’ll pay on purchases and other transactions made with your card.

Your APR won’t necessarily match the prime rate, though. That’s because banks typically use the prime rate as a starting point when setting interest rates for various financial products. Lenders often use a borrower’s credit scores and creditworthiness to determine what rate they ultimately qualify for.

The prime rate is a baseline banks use for setting APRs. So when it comes to your credit card interest rate or APR, your APR may be higher than the prime rate. 

In addition, changes in the prime rate can affect your APR. For instance, if your credit card has a variable APR based on the prime rate and the prime rate goes up, your APR may go up. If the prime rate drops, your APR could follow.

The WSJ prime rate is the most common method of determining the prime rate in the U.S. The WSJ formally updates the prime rate when 3/4 of the 30 largest banks change their interest rates. Banks may alter their interest rates in response to the Federal Reserve (the Fed), inflation and the current demand for loans.

Depending on the Fed’s view of the U.S. economy, the Federal Open Market Committee (FOMC) may adjust the federal funds rate, the overnight rate that banks use to issue short-term loans to each other. Generally, this rate also serves as the benchmark, or base rate, for prime rates. So as the Fed shifts its funds rate, financial institutions shift their interest rates accordingly. However, those shifts are usually small.

The prime rate does not change at regular intervals. Instead, it depends on the Fed’s responses to the economy and other factors. For example, the prime rate remained constant at 3.25% from March 2020 to March 2022 but increased seven times throughout the rest of 2022.

Here’s how the prime rate has changed over the past few years, according to the Federal Reserve of St. Louis:

Changes to the prime rate can affect interest rates on financial products. If a loan has a variable interest rate, the rate could go up or down based on the prime rate it’s tied to. As the rate changes, borrowers may see their interest charges accelerate or decelerate accordingly. You might see this with these types of debt:

• Credit cards

• Personal loans

• Home equity lines of credit (HELOCs)

• Adjustable-rate mortgages

• Auto loans

• Student loans

• Small-business loans

If you’re wondering whether prime rate changes affect your credit account or loan, check your monthly statement. If you’re a Capital One customer, you can find your current APR—and determine whether it’s based on the prime rate—by looking at the Interest Charge Calculation section of your credit card statement.

Yes, it can. Your minimum payment might include interest charges. And if you have a variable APR that uses the prime rate as a base, a change to the prime rate could change your minimum payment.

Most changes to the prime rate will have a pretty small impact on your monthly interest charges. For instance, if you have a balance of $500 and your APR goes up 0.25%, your increase in interest charges would be only about 10 cents. Even if you carry an average daily balance of $10,000, that same rate change would mean your monthly interest charges would increase by about $2.

Commercial banks and lenders use the federal funds rate to determine the prime rate. The prime rate, in turn, provides a baseline to set their interest rates. If you have a loan or credit card with a variable interest rate, your interest rate might change based on fluctuations in the prime rate. 

Understanding how the prime rate can impact your personal finances is a great start to keeping your interest charges low. Whether you’re shopping for a new credit card or looking to upgrade, it can help you be a smarter consumer with better control of your credit. 

Looking for a low-interest card? Check out Capital One’s low intro APR credit cards and see if one is right for you.