Prime Lending Rate and How Does it Impact You

The prime rate or prime lending rate is the interest rate at which the commercial banks give out loans and other financial products to their customers with a high credit rating. On 9th April 2010, the Reserve Bank of India (RBI) introduced the Base Rate system, which was effective from 1st July 2010. According to this new system, banks cannot lend below the base rate set by the RBI. 

If you’re looking for a personal loan or home loan, understanding the prime rate and how it works will help you determine how much you’ll pay in interest to the lender. This blog helps you understand what the prime rate is, the current prime lending rate, how it affects you and more. Read on!

What is Prime Rate or Prime Lending Rate?

The Prime Lending Rate (PLR) or Prime Rate is an internal reference rate set by banks, financial, and lending institutions to determine interest rates on floating-rate loans. It is very similar to any other interest rate; it compensates lenders for the risk they take when lending to customers. In setting the prime rate, banks and financial institutions take into account the fluctuations and volatility in the economy and the markets. 

It is important to note here that the prime lending rate is generally lower than the interest rate charged to other borrowers, who might carry with them a higher possibility of defaulting on the loans. 

The costs of funds, operating expenditures and a minimum margin to fulfil requirements of capital charge are some of the important parameters that help in determining the prime lending rate. However, while the prime rate does not directly affect the majority of consumers, it serves as the baseline for many customers and small business loans. 

As of July 1 2010, the Base Rate scheme replaced the Benchmark Prime Lending Rate. The Base Rate encompasses all aspects of the loan rate that are shared by all types of borrowers. Banks are permitted to calculate their real lending rates on loans and advances using the Base Rate and any other customer-specific charges deemed suitable. 

All loan categories are required to be priced solely in terms of the Base Rate. The Base Rate scheme applies to all new loans as well as existing loans that are up for renewal. Since the Base Rate is the minimum rate for all loans, banks are not permitted to lend at rates lower than the Base Rate.

What is the Current Prime Lending Rate?

The base rate is 8.80% per annum as of July 2022. 

The interest rate on loans linked to the prime rate is subject to fluctuation based on changes in the Base Rate. The margin between your variable rate of interest and the base rate will be determined by factors such as your credit rating, the quality of the collateral, the industry risk profile, the tenure, account behaviour, basis risk, and so on.

Impact of Creditworthiness on Prime Lending Rate

Banks and lending institutions perceive creditworthy customers to have a low risk of defaulting. The actual loan cost is determined by your creditworthiness and the credit risk premium. All commercial banks in India are permitted to set their own base rates in accordance with the RBI’s norms and regulations.  

If you have a stellar credit profile, a history of repaying your debts in time, and overall have exhibited healthy credit behaviour in the past, you can be considered a creditworthy borrower by lending institutions. This can lead to better loan terms and most importantly, a lower prime lending rate.

Also Read

Prime Lending Rate, MCLR, RBI Base Rate Impact on Loans Explained

What is Base Rate, How it is Calculated, And its Effect on Bank Customers

History of Prime Lending Rate

Benchmark prime lending rate (historical data)

Difference Between Prime Lending Rate and Variable Interest Rates

If you have debt with a variable interest rate, the prime rate is particularly crucial because the bank can adjust your rate. This affects the interest rate on credit cards, variable-rate mortgages, home loans, personal loans, etc. If the prime rate rises, the bank may charge you a higher interest rate, increasing your monthly payment on the variable debt. 

How Does the Prime Lending Rate Affect You?

Only the most creditworthy corporations with excellent credit scores are eligible for the prime lending rate. Changes in the prime rate that occur over time may have an impact on regular borrowers. The prime lending rate influences interest rates offered to individuals on personal loans, small business loans, credit cards, home loans, etc. and is also determined by banks in consideration of the borrower’s credit history.  

A rise in the prime rate may not have an immediate impact on you. However, the prime rate does, over time, push interest rates in the same way. By keeping an eye on prime rate trends, you may anticipate how much it will cost to borrow and plan accordingly.

Final Word

In general, the prime rate or prime lending rate is reserved for the most creditworthy customers—those with the lowest default risk. The interest rate that a bank charges a borrower is mostly determined by default risk. Because a bank’s best customers have a low risk of default, the bank can charge them a lower interest rate than a customer who has a higher risk of defaulting on a loan.

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