Prime Time

QUESTION:

I always thought the prime rate was the lowest interest level for borrowers with the best credit. Is this still true?

ANSWER:

The “prime rate” traditionally has been seen as the best rate for the best borrowers. In the 1993 edition of the “Language of Real Estate” (Kaplan, 2006), a standard industry reference written by attorney John Reilly, the prime rate is defined as “the minimum interest rate charged by a commercial bank on short-term loans to its largest and strongest clients (those with the highest credit ratings).” (Author’s parenthesis.)

Today, the term “prime rate” is defined differently. Bank of America, as one example, explains that “the prime rate is the rate of interest publicly announced from time to time by Bank of America as its ‘prime rate.’ The prime rate is set by Bank of America based on various factors, including the bank’s costs and desired return, general economic conditions and other factors, and is used as a reference point for pricing some loans. Bank of America may price loans to its customers at, above, or below the prime rate.

“In some Bank of America loan documentation, the term ‘reference rate’ has been used to refer to this lending rate. The terms ‘prime rate’ and ‘reference rate’ refer to the same rate.”

As this is written, the prime rate is generally at 3.25 percent. This is a low rate by historic standards – the prime rate actually topped 21 percent in 1980; in 1947 it hit 1.75 percent.

The prime rate can change at any time ,and individual lenders may elect to have different prime rates. For borrowers, the prime rate should be seen as a quickie way to look at general interest levels. The more important measure is to see what a specific mortgage costs in terms of interest, fees and charges. As always, you’re best-served shopping for mortgages and letting lenders compete for your business.