What is the Prime Interest Rate in Commercial Lending?
The prime interest rate is the interest rate banks charge their most favored customers, or those with a good credit history due to their low default risk. Generally, the customers who are eligible to receive loans equal to prime interest rate are business customers who own retail, office, or industrial properties, among others.
The rate also serves as a benchmark for a variety of commercial real estate loans, such as mortgage loans and small balance loans. For example, if a commercial property loan is priced at 3% over the prime interest rate and the rate is 7%, that means the prime rate is 4%. However, the prime interest rate is based on the Federal Funds Rate, changing as often as every six weeks or remaining the same for years.
What is the Federal Funds Rate?
The Federal Funds Rate, also known as the ''Fed Funds Rate'', is the interest rate banks may charge each other for overnight lending to one another. Although very few institutions are qualified to receive these loans, the Federal Reserve Bank still sets a minimum amount that financial institutions must withhold in the case of bank failure.
The monetary policies of the Federal Reserve are made up by the Federal Open Market Committee, or FOMC, who are in charge of supervising open market operations. The Federal Open Market Committee is also responsible for meeting regularly to set the interest rates that are charged to banks. Thus, a higher interest rate will in turn causes the banks to charge higher interest rates to their customers. The Fed Funds Rate is used as a point of reference for all other rates, such as the prime interest rate in the United States.