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ACU Blog  / Prime Rate Explained See How It Impacts HELOC Rates and Your Wallet
30 December 2021 / 4 minute read

Prime Rate Explained See How It Impacts HELOC Rates and Your Wallet

Because HELOC rates are variable, there is a ripple effect of changes that cause the prime rate and your HELOC rate to fluctuate. Discover the connection.

When the mainstream media covers banking or the economy, the term “Prime Rate” often gets discussed. These reports often lead everyday people to draw a connection between decisions made at the Federal Reserve and the changes to HELOC rates, personal loans, and other types of borrowing. Truth be told, The Fed doesn’t necessarily have a direct impact on rates offered by community credit unions. However, The Fed’s policy-making powers can save or cost everyday people money on existing variable-rate lines of credit as well as your next fixed-rate loan.

What is the Prime Rate?

Often referred to as “Prime” or the “Prime Lending Rate” by finance professionals, the prime rate involves the interest commercial banks offer to customers with near-perfect credit histories, as well as large corporations. That’s largely because they are highly unlikely to default. The prime rate is typically determined by a federal funds rate, or “overnight rate,” that lending institutions may use to borrow from one another. In many cases, the prime rate usually runs approximately 3 percent higher than the overnight rate.

It’s essential to understand that a single prime rate does not necessarily exist. To a large degree, lending institutions set their own interest figures, and discussions about prime rates often hover around an average of the financial sector. Perhaps the one static and widely agreed-upon prime rate measure is that published daily by the Wall Street Journal. Although community banks are in no way bound by the financial media resource’s number, it is widely considered a prime rate touchstone.

Lenders tend to raise or lower interest charges on loans and lines of credit when the prime rate fluctuates. But community banks are under no obligation to follow suit. Local credit unions may include lower rates and fees regardless of the nationally recognized prime rate direction.

For local lending purposes, the prime represents a baseline number for establishing HELOC rates and the interest charged for Home Equity Loans, Business Loans, Credit Cards, and unsecured borrowing. Although qualified borrowers may not necessarily see the prime rate referenced during the application and approval process, it’s a component built into loans and lines of credit and is typically mentioned when viewing online HELOC rates.


Who Determines the Prime Rate?

A misconception exists that the Federal Reserve sets the country’s prime rate. The fact of the matter is that individual banks determine the prime rate. That being said, they are influenced by The Fed’s “federal funds rate,” established by the Federal Open Market Committee.

To everyday people interested in leveraging home equity or a top-notch credit score, the methodology of getting to a prime rate seems overly complicated. Let’s simplify the process with a simpler explanation.

There are 12 Federal Reserve Districts that operate separately but under some supervision by the Federal Reserve Board of Governors. These bodies usually come together eight times per year to discuss and decide whether adjustments to the federal funds rate are warranted based on wide-reaching economic factors. The Fed may also announce emergency changes during times of crisis, such as the Great Recession or the coronavirus pandemic.

When the Fed moves to raise or lower the federal funds rate, lending institutions usually adjust accordingly. So, although The Fed doesn’t necessarily set the prime rate, its actions ripple across the banking sector. Variable HELOC rates may change overnight, and loan products typically adjust as well.

When water cooler discussions or the mainstream media references The Fed as raising or lowering the prime rate, they are skipping a few steps. But a practical understanding of the process is that when The Fed makes changes, the banking industry adjusts in accordance with those decisions.


How is the Prime Rate Determined?

It may be more accurate to say that the prime rate is not actually determined. It’s influenced. To understand how the prime rate is influenced, one must look to The Fed’s methods for changing the federal funds rate. The eight Fed gatherings — also known as the Federal Open Market Committee — enact changes to the federal funds rate. Congress empowers this group to set U.S. monetary policy to promote robust employment, price stability, and reasonable long-term interest rates, among other duties.

Acting as a central bank, relatively free from political control, the Fed also has a rarely used tool at its disposal called Quantitative Easing. The Fed can leverage its authority to expand access to private credit, reduce interest rates, and promote commercial investment and economic activity. Quantitative Easing measures have been employed during periods of upheaval. Following the 2008 financial crisis, for example, The Fed used Quantitative Easing to help stimulate the economy by dropping the federal funds rate.

When The Fed takes action to raise or lower the federal funds rate, it’s like tossing a stone into a calm pool of water. The ensuing ripples cause changes to HELOC rates, business loans, and a wide range of borrowing.


How are HELOC Rates Affected By the Prime Rate?

The monthly dollar amounts homeowners pay due to HELOC rates as a result of prime rate fluctuation can be uneven. Because HELOC rates are usually variable, the ripple effect from the federal funds rate, through the overnight rate, and into the prime rate, impact working families’ wallets.

When The Fed tamps down the federal funds rate, the effect usually results in HELOC rates declining. For example, if the officials at the next Federal Open Market Committee decide the economy is better served with lower rates, your HELOC payment could go down. Unfortunately, the precise opposite rings true as well. To give potential borrowers an idea of prime rate fluctuations, consider the following economic data.

  • Prime Rate Low Points of 3.25 percent:
    1955, 2009-2015, and March through December 2021.

  • Prime Rate Double-Digit Periods:
    1974, 1978,-1985, 1988-1990.

During the last 10 years, the prime rate has not exceeded 5.50 percent. However, The Fed influenced the prime rate higher beginning in November 2015 as the economy began to come back online following the Great Recession and recovery. After the pandemic caused global economic disruption, rates fell back to 3.25 percent.

In terms of variable HELOC rates, The Fed may impact borrowers’ monthly payments next year and beyond as it has since 1913. The conventional thinking surrounding inflation is that raising interest may help steady the economy and pricing.


Is There an Alternative?

If the prospect of your HELOC rates being affected by The Fed makes you uneasy, community credit unions offer fixed-rate alternatives. Property owners who wish to leverage their equity and secure the lowest rate possible can apply for Home Equity Loans.

If you prefer the flexibility of the draw and repayment period, applying for a Home Equity Line of Credit may be the best solution for you. Local credit unions offer applications to HELOCs and Home Equity Loans because both solutions offer unique proven benefits. For help determining which solution is best for your financial situation, please contact Allegiance Credit Union today!

For more tips on how prime rate and other factors impact HELOC Rates, review our "Top 12 Home Equity Line of Credit (HELOC) Questions Answered" guide.

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