Prime Rate’s Impact on Borrowing and Lending

October 19, 20236 min read
Prime Rate’s Impact on Borrowing and Lending
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Key Takeaways

  • Expressed as a percentage, the prime rate is the interest rate that lenders, including most commercial banks, use to set their annual percentage rate (APR).
  • Any loan with a variable interest rate, including home equity lines of credit, adjustable-rate mortgages, auto loans, and small-business loans, can be impacted by the prime rate to which the variable rate is tied.
  • The prime rate, which is published daily by The Wall Street Journal, can change based upon factors including the existing demand for loans, inflation, and the federal funds rate.

It seems as though every other national or business news report at some point mentions the term “prime rate.” It is no wonder, really, since the interest rate can have an impact on individuals as well as the broader financial world, particularly as it relates to borrowers.

But what does “prime rate” mean, and what is it today? That and more are covered below.   

What is the Prime Interest Rate?

Expressed as a percentage, the prime rate is the interest rate that lenders, including most commercial banks, use to set their annual percentage rate (APR).

However, a borrower’s interest rate will not necessarily be the prime rate since banks tend to use the rate merely as a starting point when establishing interest rates for financial products. One’s credit score and will also be factored in, along with other possible determinants.

Usually, the most creditworthy customers get the prime rate on loans. These typically are corporations who seek to borrow from other banks to finance their operations with debt.

The prime rate, which is published daily by The Wall Street Journal, can change based upon factors including the existing demand for loans, inflation, and the federal funds rate.

The Federal Open Market Committee sets the federal funds rate, which determines the prime rate.

What is Prime Rate Used For?

The prime rate is the interest rate used by commercial banks to set interest rates for credit cards or other loan products.

The rate is the baseline used by most banks to establish the interest rate offered to customers for credit cards or other loans.

How Has Prime Rate Changed Over Time?

Understanding the history of the prime rate and how it changes over time can help borrowers grasp key considerations when looking into financing options.

For example, according to Federal Reserve of St. Louis data from Mach 16, 2017, to Dec. 21, 2023, the prime rate has fluctuated between a low of 3.25% on March 16, 2020, to the current high of 8.50%. In 2017, the rate rose from 4.00% to 4.25% to 4.50%.

How Does Prime Rate Affect Borrowers?

Primarily, the prime rate directly affects the interest that credit card holders and other borrowers pay on their cards and other loans. 

Because the rate is the baseline banks use, one’s APR or interest rate may exceed the prime rate. Further, rate changes can affect the APR. For example, if one has a credit card with a variable APR that is based on the prime rate, and the rate increases, one’s APR may do so as well. The opposite is also true. To see whether the prime rate affects one’s credit account, holders can check their monthly statement.

Lenders’ most creditworthy clients are typically the ones who get the prime rate for small business loans, mortgages, or personal loans. For other borrowers, the prime rate is simply the starting point.

Also, any loan with a variable interest rate, including home equity lines of credit, adjustable-rate mortgages, auto loans, and small-business loans, can be impacted by the prime rate to which the variable rate is tied.

Prime rate changes may also affect one’s credit card minimum payment, which might include APR-based interest charges. So, if one’s APR is impacted by a rate change, one’s minimum payment may also change.

Note that most prime rate changes will usually have a minimum effect on monthly interest charges. For example, if one’s credit card balance is $500 and the APR rises by 0.25%, the monthly hike in interest charges would be about .10. 

What is Not Affected by Prime Rate Changes?

There are loans that are not affected by the prime rate, including any loan or credit line that has a fixed rate, a rate the bank sets, or rates that are tied to the Secured Overnight Financing Rate (SOFR). Student loans tied to SOFR changes will also be unaffected.

How is Prime Rate Different from Overnight Rate?

The federal funds rate is the overnight rate that banks use for lending money to each other, and which influences the prime rate. The Federal Reserve – the Fed – can adjust the federal funds rate, depending upon how it perceives the state of the U.S. economy. Such adjustments usually affect the prime rate, albeit not significantly.

In other words, the Fed sets the federal funds overnight rate, which serves as the foundation for the prime rate. In turn, the prime rate is the beginning point for other interest rates.

How to Invest in Real Estate

There are less-volatile options for investors that are not prime rate-dependent, including what are called “alternatives” – essentially any asset class other than stocks or bonds. They include art, private credit, venture capital, legal finance, and more.

They also include real estate. There are a number of ways in which investors can enter the real estate market, which remains popular due to its potential provision of passive income, property appreciation, an abundance of property types, tax favorability, and more. 

For example, there is real estate private equity, best suited for institutions and high-net-worth individuals. There are also real estate investment trusts, or REITS. Such trusts are commonly likened to mutual funds and target investors who seek real estate ownership without the responsibilities of the physical property. The offerings usually include retail spaces, apartments, hotels, and office buildings.

The alternative investment platform Yieldstreet, which has the broadest selection of alternative assets available, offers private market real estate opportunities — with an accessible $10,000 minimum.

As an alternative investment – essentially any asset class other than stocks or bonds — real estate can reduce portfolio volatility, protect against inflation and other economic instability, potentially improve returns, and importantly, diversify holdings. Creating an investment portfolio comprised of differing asset types can mitigate overall investment risk over time. In fact, diversification is a hallmark of long-term investing success.

Invest in Real Estate

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Alternative Investments and Portfolio Diversification

Alternative investments can be a good way to help accomplish this. Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings. 

Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk. 

In some cases, this risk can be greater than that of traditional investments.

This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million.  These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform.

However, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments. 

Moreover, investors can get started with a relatively small amount of capital. Yieldstreet has opportunities across a broad range of asset classes, offering a variety of yields and durations, with minimum investments as low as $10,000.

Learn more about the ways Yieldstreet can help diversify and grow portfolios.

Summary

The prime rate primarily helps financial institutions decide how much interest to charge individuals and businesses for loans, mortgages, credit cards, and related products.  Keep in mind that there are also less-volatile ways to invest that have low correlation to prime-rate fluctuations, and which can diversify investment portfolios.

We believe our 10 alternative asset classes, track record across 470+ investments, third party reviews, and history of innovation makes Yieldstreet “The leading platform for private market investing,” as compared to other private market investment platforms.

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