If you have a credit card, a loan, or a mortgage, you have probably heard the term prime rate. But what does this term mean and is it important to when and how you receive a credit card? The answer is yes. It is one of the most crucial points when looking at credit card interest rates and deciding if that particular card is for you. Understanding the basics about prime rate and interest rates in general, can help you better understand the terms of your credit cards.
The Basics of Prime Rate
Prime rate began as a term to show favor to the best customers. Bankers used the term to refer to the special rate they would give to only their best customers, mainly those with strong financial reputations and previously paid loans. This is no longer true. Now it simply refers to the interest rate used by banks. The prime rate is set by going 3% above the federal funds rate.
The federal funds rate is what banks charge each other for loans. This percentage is taken, three percentage points are added, and this is prime rate. Prime rate is reserved for those with impeccable credit. The federal funds rate can change up to but no more than eight times per year. When it does changes, most banks universally change their prime rate accordingly; although, some are slower at doing this than others.
Because many credit cards are through banks, prime rate applies to credit card interest rates as well. Although many credit cards have introductory offers such as 0% interest for a specified amount of time, few credit cards are offered at prime and stay at prime since it is reserved for a small percentage of customers who have virtually perfect credit scores. However, it does have a large influence on adjustable rates.
Prime Rate and Adjustable Rate Credit Cards
The financial crisis that our country is in has been blamed in part on adjustable or variable rate loans and credit cards. These types of credit cards start at one interest rate, but the rate can vary based on a variety of things including prime rate. For example, you may get a credit card that has an interest rate of 11% plus prime. Since prime varies up to eight times per year, your interest rate will vary as well.
A varying interest rate can be a fast way to get into financial trouble, especially if you carry a balance close to your credit limit. Since prime rate changes quickly and with little warning, so can your credit card interest rate. This in turn increases your balance, your monthly payment, and your available credit. If these things coincide, it is possible to go over your limit or to find yourself unable to pay the minimum due because it has increased.
Something important to remember is to always read the fine print on your credit card terms. Many bank credit cards will protect themselves from a prime rate that goes too low. Sometimes that rate will go so low that it makes some credit cards unprofitable. In order to protect themselves, your credit card terms may state that they can choose the prime rate from a three month period as listed by the federal government. They will in turn choose the highest prime rate over those last three months.
Another way they protect themselves is to state that your rate will be prime unless prime falls below a certain percentage. For example, your interest rate may be 10% plus prime unless prime falls below 5%. In this case, 5% would be the default. Adjustable rates with prime may seem great when prime is low, but when it reaches the high end, it could have financial consequences.
Finding an Interest Rate that Works For You
It would be easy if we could all pick our credit card interest rate or stay at prime rate, but this is not how credit card companies work. Your interest rate will be based heavily on your credit history, vary based on what type of card you apply for, and what benefits you want to receive through your card.
You should only go with a variable interest rate, if your finances can handle sudden increases in monthly payments, or if you are committed to paying off credit card balances before the grace period expires and interest rates accrue. If you do choose a variable rate card that involves prime rate, you can check the prime rate daily to see if it has changed so you are ready for any interest increases. Also, be sure to stay far below your credit limit on a variable card so that you have wiggle room if needed.
So before choosing a card, you can use our free credit card comparison tool to compare interest rates, rewards, and benefits from a variety of credit cards. Look over all the information carefully before you decide what card and what interest rate will work for your credit needs. Take advantage of the Credit Card Chaser right now!