![]() ![]() ![]() If the prime rate is 6% today, that means you pay 8%. For example, the bank may offer you prime plus 2%. No matter what that benchmark rate is, you pay that plus a specific percentage. The rates you pay on everything from personal loans to credit cards are based on a benchmark rate. It’s insulated from the type of manipulation Libor experienced because it’s based on actual financial transactions rather than (potentially make-believe) estimates.Īnd now the part you’ve been waiting for - how all this financial hullabaloo affects you. banks charge each other for Treasury bond repurchase agreements. banks that use Libor are transitioning to SOFR, the Secured Overnight Financing Rate. Knowing that, it should come as no shock many U.S. The powers that be used what we now know to be a lower-than-realistic Libor to set the rates on investments used to insure subprime mortgages against default - oops. That may actually explain the role LIBOR played in the Great Recession. Then, in the early 2010s, it came out that Barclay’s (and likely other banks) were manipulating the numbers to make the picture appear rosier than it was. Historically, it has influenced everything from the rates banks charge each other to the cost of financial instruments like savings accounts and mortgages. Lest you think that has nothing to do with you, there’s more. It’s based on reporting banks’ quotes for how much they’d pay to borrow money. As a benchmark, it’s an alternative to the prime rate, usually for larger loans, such as those taken out by businesses. As its non-initialized name suggests, Libor (pronounced LIE-bor) is a global benchmark rate analyzing the rates among the top world banks to set its benchmark. The “London Interbank Offered Rate,” as it is otherwise known, has been plagued by scandal. They just use what works, and the federal funds rate or WSJ method keeps them competitive and in the black.īanks then use the prime rate to set the rest of their rates - i.e., the rates they give you - which will be higher based on how your creditworthiness compares to prime customers’ creditworthiness. Importantly, there’s no requirement banks change their rates along with the Fed or even use that rate to begin with. If they wanted to, they could just roll dice. Some even just use the prime rate The Wall Street Journal publishes. The prime rate can be whatever the bank wants, but most banks use a similar guideline to set it, the federal rate plus 3%, give or take. That’s right: It’s a benchmark rate that uses another benchmark rate to set its benchmark. It’s usually based on the federal funds rate. It’s generally the rate they give big corporations.Įach bank establishes its own prime rate. The prime rate is the rate banks charge their best customers. They can borrow and lend among themselves to ensure they all have the required resources in those accounts. The federal funds rate influences how much real money banks must keep in their reserve accounts by law, which is a certain percentage of their deposit accounts. It’s usually a short range, such as 3.70% to 4%. The committee that sets it bases it on economic indicators like inflation. The federal funds rate, also called the federal interest rate, is a rate set by the Federal Reserve. There are many different benchmark interest rates globally, but understanding the primary American benchmarks goes a long way to understanding how they work in general. Libor and SOFR, its successor, also make an occasional appearance. The most talked-about benchmark interest rates in the United States are probably the federal funds rate and the prime rate. First, there are many different benchmark interest rates. ![]() But as with many things in the world of finance, it gets more complicated in its execution. For example, when you get a mortgage, the interest rate you pay is the benchmark rate, also called a reference rate, plus a certain percentage. That’s why it’s crucial you understand what benchmark interest rates are and how they work.Īt its most basic, a benchmark interest rate is an interest rate that determines the amount of other interest rates. If you have credit cards or plan to borrow money, it affects your financial life too. They were referring to a type of benchmark interest rate that influences a lot about financial life in the United States. You’re also probably not alone if you’ve always wondered what on earth they were talking about but were too afraid to admit you didn’t already know. If at any point in the last six months talk of the Federal Reserve changing interest rates has blown up your media, you’re not alone. Higher benchmark rates mean a higher cost of borrowing money.Two important benchmarks are the federal funds rate set by the Federal Reserve and the prime rate set by banks.A benchmark interest rate is an interest rate that determines the amount of other interest rates.
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