The prime rate stood at 8.5% in early January 2024. The Wall Street Journal publishes that figure, and it traces back to a single decision made in a Federal Reserve meeting room: the federal funds rate range of 5.25% to 5.5%.
The federal funds rate is what banks and other depository institutions charge one another for overnight loans of reserve balances. The Federal Open Market Committee sets a target for it. Before the 2008 financial crisis, the Fed hit that target by buying and selling securities on the open market, which adjusted how many reserves were in the system.
How the tool changed
The record shows the approach shifted after late 2008, when the committee set a near-zero target range. Between late 2008 and October 2014 the Fed bought large amounts of longer-term securities, aiming to push longer-term rates down and support jobs. A policy normalization process began in December 2015, and the Fed added overnight reverse repurchase agreements as a supplementary tool to keep the rate inside its range. In September 2019 it turned to repo operations to keep reserves ample. Since 2021 it has run standing repo operations, which cap upward pressure on rates.
From the Fed to the household
The Fed does not set what a consumer pays. It sets the price banks pay each other, and the rest follows with varying strength.
The link to the prime rate is the tightest. Banks can choose their own prime, but the benchmark published by the Journal, built on the ten largest U.S. banks, generally moves in step with the Fed. As a rule it runs three percentage points above the top of the federal funds range. At the bottom, in December 2008 and again in March 2020, the funds range was 0% to 0.25% and prime was 3.25%. The highest prime on record was 21.5%, in December 1980.
Credit cards sit right on top of that benchmark. A card agreement often reads like a formula: the Motley Fool’s example is 14.99% on top of prime. If prime is 5%, the cardholder pays 19.99%. Raise prime a full point and the card rate becomes 20.99%. Home equity lines of credit work the same way, and so do many adjustable-rate mortgages.
Mortgages and auto loans are a looser connection. Neither is tied directly to prime. But the Fool notes that the climb in prime during 2022 and 2023 was a major catalyst for mortgage rates reaching multidecade highs. Brett Sinnott, a secondary-marketing director at CMG Mortgage Group, told Fox Business that banks facing higher borrowing costs pass them along to customers. The Fed also moves mortgage rates through its bond purchases, because buying mortgage bonds and Treasuries lifts demand and tends to hold rates down.
Auto loans are looser still. Paul Taylor, chief economist at the National Automobile Dealers Association, told Fox Business that auto rates do not follow the funds rate step for step the way card and credit-line rates do. Lenders also weigh how confident they are of being repaid, what a used car would fetch if they are not, and where inflation is headed.
Lenders typically add a margin, such as 2 percentage points, to prime. A borrower’s credit score and payment history then set where in the range the final rate lands.
Sources
- Open Market Operations – Federal Reserve Board
- What Is the Prime Rate? – The Motley Fool
- How the Fed Affects Your Life and Money – Fox Business
