You may have heard that the better your credit score, the better your potential loan rates and offers may be. Why is that? That’s because your credit score determines your creditworthiness. A good credit score may qualify you for what’s known as a prime loan.
Here, what a prime loan is and how it works.
Understanding a Prime Loan
To understand a prime loan, it’s important to understand the prime rate. The prime rate is established by banks as the interest rate given to prime customers. This number is based on the federal funds rate set by the Federal Reserve.
When interest rates are low, the prime rate across banks will be low. But if the Fed raises interest rates, rates across banks — even for prime borrowers — will also increase.
This matters when you’re considering a fixed-rate loan, like a mortgage or a personal loan. Lower interest rates now mean that you will lock in a lower rate for the life of your loan. But prime rates also extend to variable-rate debt, like credit card debt or a home equity line of credit (HELOC).
Prime Loan Borrowers
When the bank sets its rates, they set a prime rate as the basis of their loan rates, which may be higher or lower based on the creditworthiness of each applicant. The prime rate is set considering the Federal Reserve rates, as well as other factors including the bank’s own desired return on the loan. But in general, prime rates are very similar, if not identical, between major banks.
According to the Consumer Finance Protection Bureau (CFPB), borrowers with a credit score of 660 to 719 generally receive prime rates. Borrowers with scores above 720 are considered “super-prime” borrowers, and will receive even more favorable interest rates. The interest rates for super-prime borrowers will be lower than the prime rate.
Here are the rate categories for borrowers:
| Category | Credit Score |
|---|---|
| Deep subprime | Below 580 |
| Near prime | 620 to 659 |
| Prime | 660 to 719 |
| Super prime | Above 720 |
Knowing your credit score can help you assess the category you will fit in.
Prime Loan Rates
As mentioned above, prime loan rates are set by the bank and change based on the federal fund rate. When the federal fund rate moves, so will the prime rate. As of this writing, the prime rate is 4.75%, according to the Wall Street Journal.
So does this mean that any loan you apply for will have a 4.75% interest rate? No. APR rates will vary based on the type of loan you apply for. Banks may have their own formula but there are some rules of thumb.
For example, credit card interest rates are generally set at “prime + 13.99%.” As the prime rate changes, so will your interest rate. But in general, the higher your credit score, the lower your interest rates will be.
Prime Loan Example
How Does the Prime Loan Rate Affect You?The prime loan rate affects everyone. From buying a car to buying a house to opening a credit card, the prime loan rate will determine how much interest you’ll pay. You may be more vulnerable to prime loan rate fluctuations if you have a lot of variable interest loans, like credit card debt. As the prime rate climbs, so too might the APR of your cards. When you see a prime rate hike, it can mean that your APR will quickly rise as well.
Conversely, when the prime rate falls, some people use that time to refinance a mortgage or lock in a rate for a loan, like a personal loan or an auto loan.
Because the prime rate affects credit cards, some people who carry a high credit card balance who have good credit may consider using a personal loan to consolidate their credit card debt. This is one way to use a personal loan to pay less overall interest, depending on the rates offered.
What Is the Difference Between a Prime Loan and Subprime Loan?
There are a few differences between a prime loan and subprime loan. Not only do prime loans have the most favorable interest rates, but they also may affect how large a loan you can take, among other things. Here, some differences between a prime loan vs. a subprime loan.
Interest Rates
Interest rates are one of the most obvious differences between a prime and subprime loan. But even within categories, like a prime borrower, there may be subcategories that receive different interest rate offers. For example, a prime borrower with a credit score near super-prime territory may receive more favorable rates than a borrower whose credit is close to subprime.
Repayment Periods
A subprime borrower may also have fewer options when it comes to repayment periods. They may have a shorter repayment period at a higher interest rate than a prime borrower.
Down Payments
A prime borrower may have a low, or no, down payment required for a loan. But subprime borrowers may have to make a larger down payment to qualify for a loan. This is especially true for loans like car loans or mortgages.
Loan Amounts
Prime borrowers may have access to greater loan amounts than subprime borrowers.
Fees
Non-prime borrowers may also have to pay more loan fees than a prime borrower. This may be due to the types of loans they can access. If they can’t get a loan from a traditional bank, a subprime borrower may seek payday loans or other loans that require fees. Different types of personal loans besides loans offered by traditional banks may include payday loans, hard money loans, and other loans that may require collateral, or have high fees and interest rates.
What Do You Need To Qualify for a Prime Loan?
Your credit score will determine what type of loan is offered to you. But a lender will take other details into consideration, including your credit history and employment status. But a good rule of thumb is to make sure your credit score is as high as possible before you apply for a loan to receive the most favorable terms.
The Takeaway
The prime rate is out of your control. But so much of your interest rate is under your control, including your credit score. Building your credit score can help you have the most competitive loan options, whether you’re researching personal loans, credit card offers, mortgages, or refinancing your student loans.
If you’re applying for a personal loan, personal loan approval tips include assessing your credit score. If it’s not where you’d like it to be, you might want to consider building your credit before applying for a personal loan. Subprime personal loans may exist, but they may be for lower amounts at higher interest rates than ones offered for prime borrowers.
Rates may be different across banks so it’s worth comparing personal loan interest rates. You can check your rate for personal loans without it affecting your credit score. Doing so can help you determine the types of loan rates, as well as amounts, you may be eligible for.
FAQ
What does prime mean in loans?
Prime in loans means the borrower is considered a low lending risk. The bank will set a prime rate that will then be the basis for interest rates across lending products, including mortgages, car loans, personal loans, and credit card offers.
Is there a difference between prime loans and subprime loans?
Yes. Prime loans are given to people whose credit scores generally fall into a 660 to 719 range. (Borrowers with credit scores above that are considered superprime borrowers and may be given even more favorable rates.) But there are also categories within the prime range — people with higher credit scores may get a lower rate than people with lower scores, even if their scores fall into the “prime” category.
In addition to interest rates, prime borrowers may also have longer repayment period options, more access to credit, lower fees, and a smaller down payment obligation than subprime borrowers.
What is the current loan prime rate?
The current loan prime rate is 4.75%.
Photo credit: iStock/Imagesrouges
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