From my understanding it's tied to something called the 'prime rate', but what is that really and who determines what it is? Is it always less than the rate of inflation?
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Welcome, Amir! Excellent question.– Chris W. ReaJan 8, 2010 at 1:26
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As for " Is it always less than the rate of inflation?", the prime rate is always 'more' than the rate of inflation. The purpose of lending money and charging an interest rate is to make a profit, so if the interest rate is not even keeping up with inflation, then there will be no profit. I guess that is why there is a concept of 'real' interest rate which is the (interest rate - rate of inflation). If this becomes negative, then the lender has no incentive to lend money.– Victor123Feb 5, 2014 at 14:50
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It will be written on the broker's website which rate they are using as the 'benchmark'. Varies from broker to broker.– Victor123Apr 24, 2015 at 19:15
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1 Answer
The prime rate is the interest rate banks use amongst themselves to lend money to each other only.
It is used as the basis (sometimes) for what interest rate banks charge you. The prime rate is based loosely on the Fed rate. There is a committee that meets regularly to set this and other industry interest rates.
http://en.wikipedia.org/wiki/Prime_rate
I am not 100% positive the following is totally accurate
The banks keep our deposits and pay us interest for doing so. They are paying us interest because they take yours, mine and everybody elses deposits as a large lump sum and invest that money. Sometimes as business loans, sometimes as mortgages and sometimes as credit card.
The banks have a book of business that will be EXACTLY how much credit they have extended to everybody. But they do not keep that amount of cash in the vaults, only some smaller percentage of that large amount. When I use my credit card and they need to transfer money to amazon.com, if they don't happen to have enough cash that day, they will just borrow from another bank that does, and the interest rate they pay to do so is the prime rate. Since they are paying interest on the money they borrow to pay the debt I charged because they told me my credit was worth so much (...???...) they charge me a little bit more than that.
Hence your credit card or mortgage's APR being based on the prime rate.
I THINK that is what they do If I am wrong leave a comment and I will update, or the mods can.
answered Jan 7, 2010 at 17:21
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the fed rate is what the banks pay to borrow from the Bank of Canada.the prime rate is the best rate the banks can offer the consumer– TimJun 14, 2010 at 3:34