How Does Prime Rate Affect Home Equity Loans

[Nov 27, 2009.]

 

What Is Prime Rate?

If your mortgage loan has an adjustable interest rate, as many home loans do, the interest you pay is calculated using an index and a margin. Prime Rate is the index most commonly used to calculate the interest on home equity loans. The Fed Funds Rate is one of the tools that the Federal Reserve uses to control monetary policy in the US. It is commonly known as the Feds primary interest rate. Right now the Fed Funds Rate is 0.00%-.250%. The Prime Rate usually tracks the Fed Funds Rate plus 3.0%.  So, if the Fed Funds Rate is .250%, Prime Rate is 3.25%.

What Is The FOMC?

The Federal Reserve has a group of voting members called the Federal Open Market Committee (FOMC). The FOMC meets about every six weeks to review reports about the economy.  If the economy is not growing, the FOMC can lower the Fed Funds Rate to stimulate economic growth. If the economy appears to be growing too quickly, the FOMC might raise the Fed Funds Rate to slow things down. FOMC meetings are widely covered in the news. If you have been watching the news over the most recent year, you have repeatedly heard something like, "The Feds have decided to leave interest rates unchanged."

What Do FOMC Decisions Mean To Home Equity Loans?

The US has been in a deep recession. The Feds have been working overtime and pulling everything out of their bag of tricks to get the economy growing again. Before the recession, when the economy was booming, the Fed Funds Rate was much higher; Prime Rate was much higher; and interest rates on home equity loans were much higher. Home owners with adjustable home loans are enjoying historically low interest rates right now. This will change when the economy starts to grow again. Economies are cyclical beasts. Inflation will show its ugly head again and the Feds will react by pulling stimulous from the economy and tightening money by raising their main interest rate, the Fed Funds Rate. When the Fed Funds Rate goes up, Prime Rate will go up, and the interest you pay of your home equity loan will also go up.

Understand Your Home Equity Loan

When you sign loan papers, one of the documents you sign is a "note." Your note tells you how much you are borrowing, at what interest rate, and for how long. If your interest rate adjusts, it will tell you the index and margin being used. Know your index and margin. An adjustable loan must be managed for the home owner to be successful financially.

 

About Author:

Renee Morgan has been a loan officer for over eighteen years. She is also a freelance writer and guest expert for radio and TV.