Prime Rate and What it Means to Credit Cardholders
Understanding how the annual percentage rate (APR) is calculated on your credit cards is vital to managing your credit and comparing credit card offers. Often, you’ll be offered a fixed APR for your credit card which means that unless you receive written notification from your credit card company, your APR will remain the same whether the rate is for purchases, balance transfers, or cash advances. Fixed-rate offers are usually reserved for consumers with excellent credit ratings and are generally unavailable to those with lower credit scores.
How the prime rate is determined
The majority of credit card companies offer cards that base their APR on the prime rate. The prime rate is the underlying index used by banks for most credit cards, as well as for lines of credit, home, auto, or personal loans. The prime is most influenced by the Federal Funds Rate — a rate set by the Federal Reserve which fluctuates based on market conditions in the U.S.
When there is rapid economic growth, the Federal Reserve Board often raises the prime rate in order to prevent runaway inflation. If the economy is slow, the Fed may lower the prime rate to help spur economic growth.
How credit card companies use the prime rate in calculating APRs
If a credit card company is offering you an annual percentage rate (APR) which is tied to the prime rate, the interest you’ll pay on your card will fluctuate. Your credit card company will specify how many interest percentage points higher than the prime rate your APR will be set. To calculate what your APR will be, simply add that number with the current prime rate (you can easily find the prime rate online or often in the terms and conditions of the credit card offer).
For example, if the current prime rate is five percent and your credit card company is charging nine interest percent points above prime, your APR will be 14 percent.
Does a lower prime rate mean a lower credit card interest rate?
Almost all credit card issuers lower their APRs when the prime rate goes down, but not all of them do. Before you apply for any card, carefully read all of the offer details to fully understand their policies regarding interest rates.