Could you tell me whether there is any legal arrangement why the prime loans rate is pegged to the federal funds rate plus a 3%?
Thank you for your question. The fed funds rate is not a retail lending rate – it is the rate at which commercial banks can borrow from each other overnight using the Federal Reserve. The prime rate is computed by adding 3% because that is the minimum interest rate that lenders are willing to charge for high quality, creditworthy borrowers. Borrowers with lower creditworthiness won’t qualify for primate rate and can expect to pay far higher interest rates.
For more information on prime rate, you’re welcome to check out our article on the Prime Rate Formula.
Hope this helps,
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