The difference between LIBOR and Prime Rates
Prime rate, LIBOR, Interest rate, and APR are all terms used frequently in the financial industry, but what do they all mean? Knowing this information will help you become a more informed borrower, and understanding the difference between an interest rate and APR will allow you to make an informed decision that will save you money in the long run.
A loan’s interest rate is the monthly fee charged on the amount of money borrowed. Banks determine the interest rate you will pay by looking at your credit history and credit score. The higher your credit score is the lower the interest rate you will pay. Interest rates are based on one of two indices, the prime rate or LIBOR.
Prime Rate and LIBOR
Prime Rate and LIBOR are indices that financial institutions use to set their interest rates. The prime rate can be found in the Wall Street Journal and is the base rate that is available to borrowers with the best credit history and credit score from 75% of the 30 largest banks. LIBOR, which stands for the London InterBank Offer Rate, is the rate banks charge each other to borrow funds. LIBOR are short term rates that can range from overnight to one year. The rates are set by the British Bankers Association and released each day at 11 a.m. London time.
LIBOR is quoted on a daily basis representing fixed time periods ranging from 30 days to 360 days. The rate is set not by banks but by market forces in the supply and demand of Eurodollars. It then fluctuates throughout the day based upon the market's expectations for economic activity and the future direction of interest rates. With student loans, the LIBOR rate is set by the lender based on credit history and repayment plan you select.
You can ask your lender if your private student loan interest rate is based on either the Prime Rate or LIBOR, so you know how they arrive at the rates you are offered. Because of the large fluctuations between these rates, it's best to compare student loans based on APR and not prime rates or LIBOR.
The APR or Annual Percentage Rate is the rate you will pay on an annual basis including fees and discounts. The APR is the actual annual cost of the loan expressed as a percentage. The Truth in Lending Act requires all banks to provide the APR to allow you to compare different loan options on a level playing ground.
APR is an important factor to consider when looking at loans but should not be the only factor. Other factors to consider are the number of payments, total cost of loan, and monthly payment. Make sure the loan that you choose fits into your over all budget and financial picture. A loan that has a low APR but high monthly payments may be hard to maintain if the starting salary of your chosen profession does not support it. When looking at student loans, compare your all of your options before deciding.