The prime rate is the interest rate commercial banks charge their best (or prime)borrowers. It is based on banks’ cost of funds (savings rates) as well as availability of money; desire to make new loans and general market conditions. But it has become more than that: The prime rate is an index used to calculate other interest rates, both personal and business. For example, personal loan rates might be priced at 6 percent over prime. If prime were 5 percent, personal loans would cost you 11 percent. Many banks will use the Wall Street Prime rate. This is a rate set by the top lending banks in the country.
Default risk is the main determiner of the interest rate a bank will charge a borrower. Because a bank’s best customers have little chance of defaulting, the bank can charge them a rate that is lower than the rate that would be charged to a customer who has a higher likelihood of defaulting on a loan.