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Prime Interest Rates

What are prime interest rates, and how do they affect my mortgage?

Anyone who has watched any amount of financial television is familiar with the term “Prime Interest Rate.” When this rate goes up, potential home buyers are encourage to lock in their interest rates and wait, and when it goes down, they are encouraged to refinance or purchase a new house. The meaning of this interest rate, as well as how it is determined, remains obscure however. So what is the prime interest rate? And how does the prime interest rate determine the mortgage rate?

The prime interest rate is the lowest rate at which banks will lend out money. It is determined by taking the federal interest rate, which is the rate at which the government lends money to banks, and then adding a small amount of interest for insurance and profit. This usually puts the prime interest rate at about three points higher than the federal funds rate, which is also the rate of interest earned by government bonds. This means that if the federal funds rate is 1%, then the prime interest rate would be about 4%. The prime interest rate in the United States has traditionally been kept low, rising only when necessary to combat inflation. Historically, it was lowest during the housing boom of the late 00s and during the recession that followed. At this time, the prime interest rate was as low as 3%. The prime interest rate tends to be uniform across banks, although this is not rigidly enforced, and some banks may have rates of interest slightly above or below what is considered the prime rate.

Generally, the prime interest rate is only available to banks. This is because the amount of profit generated on a prime interest rate loan is very small. Therefore, banks are usually hesitant to lend out at that rate, especially since it is often only slightly above the rate of inflation. Most prime interest rate loans and mortgages are made from one back to another in quick, overnight transactions intended to prevent potential losses or insure against a possible run on the bank. Many major corporations also take such prime interest rate loans, then pay them back quickly. The point of a prime interest rate loan is to offer a company, business partner or trusted customer access to cash at the lowest possible price, so that they can reward them by offering them money that is almost free.

Prime interest rate mortgages are only rarely available to the general public, but they are not impossible. Generally they are a side benefit extended to persons who have extremely high rates of deposit or long outstanding relationships with the bank. Most bank members cannot have access to them, and those who do must follow very strict terms in order to prevent the bank from being exposed to risk. However, there are many loans which are advertised as prime interest rate mortgages or near-prime rate mortgages because they are very near the prime interest rate.

Such prime interest rate mortgages and near-prime interest rate mortgages are only extended to those with an excellent credit history and an extensive record of good banking practice. These loans were very common during the boom years of the late 00s thanks to the development of collateralized debt obligations, also known as CDOs, which permitted the risk inherent in such low interest loans to be passed on to other investors. However, when these CDOs went bust in 2008, prime interest rate mortgages became very scarce again. They are still available to some borrowers by some banks, though, and are often offered as part of federal and state housing programs.
Most of the banks currently offering prime interest rate mortgages are either community banks or credit unions. These loans are generally for small or modest amounts and are part of incentive packages to encourage people to buy a house or other small property. Many of these loans are only available to persons of limited means but a good credit history. Anyone who is interested in such a mortgage should contact local banks and credit unions, especially those founded for reasons of charity or development. Large banks sometimes extend prime interest rate mortgages to favored customers, or as part of an incentive program to encourage multiple loans and mortgages.

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