Prime Interest Rate and LIBOR
Michael Laurance  The Wealth Coach

Michael, I keep hearing about LIBOR and the Prime Interest Rate.  I know many loans, especially mortgages and credit cards are tied to one of these rates, but I honestly don't know what they are.  Can you explain them to me?

SURE!

     Many people borrow money tied to one of these benchmarks, but few people understand them or where they come from or what they mean.  So, here goes:

Prime Interest Rate:  PIR is used for many consumer loans such as mortgages, home equity products, car loans, and credit cards. You might hear your real interest rate expressed as "Prime + 2 Points" which would mean the Prime Interest Rate plus two percentage points.

This rate usually represents the rate that a lender would charge the best borrowers.  It is usually (in the US, anyway) 300 basis points or 3 percentage points above the Federal Funds Rate, which is the rate that banks lend to one another for overnight loans.  Today, the Prime Interest Rate is 3.25%.  Generally, most big banks and lenders will have the same Prime Interest Rate, and it will generally be prominently quoted in newspapers like the Wall Street Journal.

So, today, you might find an Adjustable Rate Mortgage interest rate quoted as Prime Plus One, which today would mean 4.25%.  As I mentioned, many credit cards are tied to this (like at Prime Plus Four) as are many car loans and home equity products.

LIBOR stands for London Interbank Offered Rate, or the interest rate at which banks can borrow money from other banks in London.  Typically, lenders use the rate for 1 Year LIBOR.  More important than the technical nature of each of these is what they mean to you from a practical standpoint.

LIBOR is often a benchmark for loans, such as mortgages, where the rate quoted might be LIBOR Plus 2.75 which means the LIBOR rate plus 2.75%.  LIBOR tends to change more frequently than Prime, and today is at 1.830%.  Thus a mortgage priced at LIBOR plus 2.75% would be priced at 4.5% or maybe 4.625%.  (Mortgage rates are typically priced in 1/8 of a percent increments.)

LIBOR is not as widely published as Prime, but is easily found online or in financial sections of newspapers.

I hope this demystifies some of the intended confusion about the Prime Interest Rate and LIBOR, and more importantly, what they mean to you as a consumer!