Prevailing Interest Rate Definition

The prevailing interest rate is the average current interest rate in the economy, sometimes called the current market rate. Different types of loans often have various prevailing rates. For example, because mortgage and car loans use their underlying property as collateral, the going interest rate currently offered for these types of loans may be a couple of percentage points lower than interest on a personal loan without collateral.

Where It Starts

Prevailing interest rates in the United States originate with the federal funds rate. This interest rate, set by the Federal Reserve, is what banks pay for overnight loans. Through adjusting this rate up and down, the Fed attempts to control the U.S. money supply. For example, an excess of available funds generally means the interest rate will decline. When demand outpaces supply, the funds rate increases.

What It Means for Consumers

When a bank needs more reserves than it has on hand, it borrows from banks that have more than they need to meet obligations. This type of borrowing and lending goes on constantly through the federal funds market. In turn, banks need to make a profit; to recoup what they pay in the federal funds rate and make a profit, the rate is adjusted upward and passed on to consumers, such as through personal loans and mortgage contracts. This funds rate also affects earnings on investments.

Prime Rate

The prime interest rate is typically at the lower end of the prevailing interest rate and increases or decreases depending on the current federal funds rate. The 10 largest U.S. banks determine the prime interest rate, according to Bankrate.com. Lenders offer only the most creditworthy customers loans at the prime rate. Credit card companies use the prime rate as the starting point for their interest rates; atop this they add a set number of percentage points and pass the charges along to customers through higher, personalized interest rates.

Investments

The prevailing interest rate affects what earnings banks and other financial institutions will offer on savings accounts and certificates of deposit. If rates are high on loans, savings rates typically will also rise accordingly.

Prevailing interest rates can have a significant effect on the bond market, especially on short-term bonds. Bond prices change in direct opposition to market interest rates. If interest rates rise, bond prices fall and vice versa , which keeps the value of individual bonds constant.

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