So what is all this prime lending rate about anyway?

The prime rate, as reported by the Wall Street
Journal's bank survey, is among the most widely
used benchmark in setting home equity lines of
credit and credit card rates. It is in turn
based on the fed funds rate, which is set by
the Federal Reserve.

In a nutshell, it's what determines whether or not

you can afford to pay your mortgage,your car

and anything else you have not paid off yet.

The COFI (11th District
cost of funds index) is a widely used benchmark
for adjustable-rate mortgages. The fed funds
rate is the primary tool that the Federal Open
Market Committee uses to influence interest
rates and the economy.

The prime rate is the
underlying index for most credit cards, home
equity loans and lines of credit, auto loans,
and personal loans. Many small business loans
are also indexed to the Prime rate.

The prime lending rate is the interest rate that banks charge their best clients to lend them money. As a result, this is the lowest interest rate a bank charges at any given time. The prime lending rate fluctuates in relation to the fed funds rate from the Federal Reserve Bank.

This is the rate banks charge to lend money to each other. The prime lending rate usually adjusts whenever the fed funds rate does. The prime lending rate is usually maintained at about 3 percent above the federal funds rate.

In general, the prime rate runs approximately
300 basis points (or 3 percent) above the
Federal Funds Rate, the interest rate that
banks charge to each other for overnight loans
made to fulfill reserve funding requirements.

(The Federal funds rate plus a much smaller
increment is frequently used for lending to the
most creditworthy borrowers today, as is LIBOR,
the London Interbank Offered Rate.)

The Federal
Open Market Committee (FOMC) meets eight times
per year wherein they set a target for the
federal funds rate. Other rates, including the
Prime Rate, derive from this base rate...again,
typically adding +/- 3%. The most commonly
recognized prime rate index is the Wall Street
Journal Prime Rate (WSJ Prime Rate), published
in the Wall Street Journal.

Unlike other
indexed rates, the prime rate does not change
on a regular basis; rather, it changes whenever
banks need to alter the rates at which
borrowers obtain funds.

The Wall Street Journal
defines the prime rate as "The base rate on
corporate loans posted by at least 75% of the
nation's 30 largest banks." ...that "fact" is
no longer considered to be a "fact" any longer
(and that the prime rate is simply the fed
funds target rate + 3) ...because most
corporate loans are indexed to LIBOR. When 23
out of 30 of the United States' largest banks
change their prime rate, the WSJ prints a
composite prime rate change.

So, while the Fed
funds rate is a large determinate...the rate at
which banks are actually charging for their
corporate lending is the true "final" rate.

Normally, when the prime lending rate drops,
home mortgage rates follow shortly after. The
bank is borrowing money at a lower interest
rate...so home buyers also can borrow at a
lower rate of interest.

A: But we’re not in a
normal situation. The bank’s cost of funds is
not the only variable in determining the
interest rates on mortgages. Banks always lend
at rates higher than their cost of funds.

This
difference (called margin or spread) is a
function of the bank’s perception of investment
risk.

The riskier the investment, the higher
the spread. Following the problems in the
mortgage markets, banks feel their previous
assessment of risk was too optimistic. The end
of January a 30 year fixed rate mortgage was
5.49%.

The Feds lowered the prime...and on 2/17
home mortgage rates INCREASED to 5.72%. How in
heck is this supposed to stimulate the housing
and new construction market? It’s not and it
won’t.

Housing was not the intended target of
the interest rate cut. The stimulating effect
(if it ever shows up) will come primarily from
exports. Lower interest rates will lead to a
drop in the value of the dollar, which in turn
would have a stimulating effect on exports.

Increases in consumer spending and business
investment are also possible, which goes into the mix.