Fed Funds, Prime Rate and SOFR: The Benchmark Rates Behind Loans

When the Federal Reserve makes a rate decision, headlines talk about "the" interest rate as if there were only one. In practice there are several, and they are linked rather than identical. Your credit card follows one, your adjustable mortgage may follow another, and your savings account follows none of them exactly. Knowing which benchmark sits behind each product explains why some payments change within weeks of a Fed meeting and others stay put.

The rates in one picture

Think of a short chain. The Federal Reserve sets policy. Policy shapes short-term money-market rates. Banks and lenders build their own prices on top of those rates.

The federal funds rate

Banks hold reserve balances at the Federal Reserve and lend to each other overnight to manage their cash. The rate on those loans is the federal funds rate. The FOMC does not dictate it directly. Instead, it announces a target range and uses its tools, including the interest it pays on reserve balances, to keep the market rate inside that range. For a fuller picture of the committee and its toolkit, see what the Federal Reserve actually does.

Ordinary people almost never borrow at the fed funds rate. Its importance is as an anchor. When it moves, nearly every short-term rate in the economy tends to follow.

The prime rate

The prime rate is the rate commercial banks have traditionally offered their most creditworthy business customers. Each bank sets its own, but they cluster tightly. The rate most people see quoted is a consensus figure, and by long-standing convention it sits about three percentage points above the top of the fed funds target range. That is why the prime rate usually changes right after the FOMC changes its target.

Products often tied to prime include:

• Credit cards: most carry a variable APR written as prime plus a margin that depends on your credit profile.
• Home equity lines of credit (HELOCs): commonly prime plus or minus a margin.
• Some small-business lines of credit and personal lines.
• Some private student loans with variable rates, though many use other indexes.

Because the margin is fixed in your contract, your rate moves one-for-one with the index. If prime rises by a quarter of a percentage point, a variable APR tied to it generally rises by the same amount, subject to the timing rules in your agreement.

SOFR

SOFR stands for the Secured Overnight Financing Rate. It reflects the cost of borrowing cash overnight when the loan is backed by Treasury securities, a market known as the repo market. The Federal Reserve Bank of New York publishes it each business day, based on transaction data.

SOFR became important because of what it replaced. For decades, variable-rate loans around the world used LIBOR, a benchmark built partly on banks' own estimates of what they could borrow at. After a manipulation scandal and thin underlying trading, regulators pushed the market to switch. For US dollar contracts, the Alternative Reference Rates Committee recommended SOFR, and it is now the main benchmark for new US dollar variable-rate loans and derivatives.

You may meet several versions:

• Overnight SOFR: the daily rate itself.
• SOFR averages: an average over a period of 30, 90 or 180 days, which smooths daily swings.
• Term SOFR: a forward-looking rate for periods such as one, three or six months, used in many commercial loans.

Where you are most likely to see SOFR:

• Adjustable-rate mortgages (ARMs): newer ARMs commonly reference a SOFR-based index, with a margin, an initial fixed period, and caps on how much the rate can change.
• Commercial real estate and business loans.
• Floating-rate notes and some funds that invest in them.

What does not follow these rates closely

Fixed-rate mortgages

The rate on a new 30-year fixed mortgage is driven mainly by longer-term bond yields and investor demand for mortgage securities, with lender margins on top. That is why the 10-year Treasury yield tends to track mortgage rates more closely than the fed funds rate does. The two can even move in opposite directions on a given day. We explain the link in mortgage rates and the 10-year Treasury yield.

Savings, CDs and money market funds

Banks decide what to pay depositors, and they do not simply copy the Fed. In general, yields on online savings accounts and money market funds respond to Fed moves faster and more fully than those at some traditional banks. CD rates depend on the term and on market expectations for future rates.

Auto loans and personal loans

Most are fixed rate. Their pricing reflects market rates at the time you borrow, plus your credit profile, the term and the lender's costs.

How to find the benchmark in your own loan

Variable-rate documents usually describe three things. Look for them in the loan agreement, the card terms or the periodic disclosure:

1. The index: the named benchmark, such as the prime rate as published in a specific source, or a particular SOFR average.
2. The margin: the fixed amount added to the index. This is the part negotiated for you.
3. The adjustment rules: how often the rate resets, any caps on a single change or over the life of the loan, and any floor below which the rate cannot fall.

A simple formula describes most of them: your rate = index + margin. If you see "prime plus 10," your rate is the prime rate plus ten percentage points. Whenever the index changes, your rate changes accordingly, after any delay the contract specifies.

How quickly changes reach you

The exact timing is set by your contract, so read the terms rather than assuming.

Why this matters for reading the news

When a headline says the Fed raised or lowered rates, the most direct effects land on variable-rate borrowing tied to prime or SOFR and on short-term savings yields. Effects on long-term fixed loans arrive indirectly, through expectations about future rates and inflation, which investors price into longer-term yields before and after the meeting.

That also explains a pattern that confuses many people: mortgage rates can move on days when the Fed does nothing, or move opposite to the Fed's move because markets had already priced it in.

A practical close

Pull out one statement or agreement for a variable-rate product you own, find the index, the margin and the adjustment rules, and write them in one line. That single line tells you what moves your payment and what does not. For current levels, go to the primary sources: the Federal Reserve publishes its target range and statements at federalreserve.gov, and the New York Fed publishes SOFR and the effective fed funds rate at newyorkfed.org.