What Is Prime?
Prime is a classification of borrowers, rates, or holdings in the lending market that are considered to be of high quality. This classification often refers to loans made to high-quality prime borrowers that are offered prime or relatively lowinterest rates.
Key Takeaways
- Prime is a term that refers to high quality in the lending market.
- Prime is typically associated with borrowers, loans, or rates.
- Prime loans have low default risk, high credit scores, and extremely low interest rates.
- The opposite of prime is subprime, a term for riskier loans with a higher interest rate.
- Definitions vary, but a borrower with a credit score above 660 is likely to qualify for a prime loan.
Understanding Prime
Within the credit market, prime generally refers to aspects of high-quality lending. Prime loans are considered to be one of the lowest risk loan groups a lender holds on its balance sheet. Prime loans are also typically the easiest to sell on the secondary market.
Prime borrowers have high credit scores and low relative default risks which earn prime rates from lenders. Securitized credit products comprised heavily of prime loans can also obtain several advantages.
Important
Upfront fees on Fannie Mae and Freddie Mac home loans changed in May 2023. Fees were increased for homebuyers with higher credit scores, such as 740 or higher, while they were decreased for homebuyers with lower credit scores, such as those below 640. Another change: Your down payment will influence what your fee is. The higher your down payment, the lower your fees, though it will still depend on your credit score. Fannie Mae provides the Loan-Level Price Adjustments on its website.
Prime Borrowers
A major variable in the determination of prime borrowers is their credit score. Lenders usually obtain credit scoring details based onFICOscoring methodologies. FICO scores can range from 300 to 850 with borrowers above 660 generally considered to be prime borrowers, eligible for prime loans. Borrowers with a nearly perfect 750 to 850 score can also be tagged as super-prime borrowers.
When considering a potential loan, lenders have sophisticated systems in place for loan applications and credit underwriting. A borrower’s credit score usually determines the terms they are eligible for receiving.
Other detailed variables can also be considered in the underwriting process including a borrower’s debt-to-income and total credit profile. Borrowers with a high-quality credit profile may be able to gain prime rate loans even with an averagecredit scorein some cases. Generally, the assigned terms of a loan will vary by each lender.
Prime borrowers can be more selective in the types of credit they take on since they are clients highly sought out by lenders. Prime borrowers can expect to receive a lender’s lowest interest rate. They will also often be approved for more significant amounts of financing due to their high credit quality status.
Alternatively, subprime borrowers are those generally with credit scores below 620. These borrowers will be required to pay higher interest rates. They may also have to resort to much lower quality credit offerings like those with high fees, high rates, and low balances.
The opposite of prime is subprime, meaning borrowers or loans with a high chance of default. Subprime loans played a major part in the Great Recession of 2008.
Prime Loans
Lenders categorize loans by a variety of categories for risk management purposes. Prime loans offer the lowest risk to lenders and are typically issued by traditional financial institutions that manage a variety of credit products on their balance sheet.
Following the financial crisis and subsequentDodd Frank Wall Street Reform and Consumer Protection Act, lenders in the financial industry have been required to increase the quality of loans they approve for origination. The Dodd-Frank Act implemented a number of provisions governing the credit underwriting standards specifically for banks.
The act also introduced qualified mortgages that meet certain requirements for special protections. As a result of the improved lending standards, the percentage of high-quality mortgages has increased, which has also helped to improve confidence in the economic stability of the economy.
Due to an active secondary loan market in the credit industry, lenders also have the opportunity to sell loans in the open market or sell them for securitization. Prime loans are often some of the most profitable loans for sale. In themortgagemarket, prime loan classification is also often a key characteristic for secondary market structured portfolios sold to government-supported agencies, including Ginnie Mae, Freddie Mac, and Fannie Mae.
A person with a credit score above 660 is considered a prime borrower, while one between 620 and 660 is considered near-prime.
Prime Rate
The prime rate is another component of top-quality lending. While low rates may generally be referred to as prime, there is also a prime rate quoted for several benchmark referencing purposes.
Within the credit market, rates follow a tiered schedule with the federal funds rate being the lowest, followed by the discount rate, and then a prime rate. The federal funds rate is set by the Federal Reserve Open Market Committee. This is a very short-term rate used for lending among the Federal Reserve banks.
The discount rate is slightly higher than the federal funds rate. It is also set by the Federal Reserve. The discount rate is used for Federal Reserve bank lending to commercial banks. The prime rate is slightly higher than the discount rate. The prime rate is a rate offered by banks for their highest quality borrowers, usually in the super-prime category.
The prime rate can be harder to pinpoint than the federal funds rate and discount rate. One of the best proxies for the prime rate is the Wall Street Journal’s prime rate quote. This quote is an average of the prime rates at the 10 largest banks in the United States. Since rates are generally on a tiered schedule based on the types of risks involved, a change in the federal funds rate will usually have some marginal effect on all borrowing rates overall with the discount rate and prime rate being the most directly affected.
What Credit Score Do You Need for a Prime Loan?
Prime borrowers are considered to be those with a FICO score of 660 or above, according to the Consumer Finance Protection Bureau. Those with a credit score above 720 may be classified as super-prime borrowers.
What Is the Prime Rate for Loans?
According to the Wall Street Journal, the prime rate in the U.S. is 8.25% as of May 4, 2023.
What Is a Super-Prime Loan?
A super-prime loan is a loan to borrowers who are considered extremely low-risk. These borrowers typically have excellent credit history and sufficient income or assets to repay their debts with no difficulty. Depending on the lender, borrowers with a credit score above 720 or 750 may qualify for a super-prime loan.
