What Does Prime Mean?
Prime is a classification of borrowers, rates or holdings in the lending market that are considered to be of high quality. This classification refers to loans made to high quality prime borrowers that are offered prime or relatively low interest rates.
Prime loans are considered to be one of the lowest risk loan groups a lender holds on its balance sheet. These loans are also typically the easiest to sell on the secondary market.
A major variable in the determination of prime borrowers is their credit score. Lenders usually obtain credit scoring details based on FICO scoring methodologies. FICO scores can range from 300 to 850 with borrowers above 620 generally considered to be eligible for prime loans.
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. Other variables are also 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 average credit score in some cases.
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 larger amounts of financing due to their high credit quality status.
Lenders categorize loans issued 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 high credit products on their balance sheet.
Following the financial crisis and subsequent Dodd Frank Act, lenders in the financial industry have been required to increase the quality of loans they issue. Dodd Frank implemented a number of provisions governing the credit underwriting standards specifically for banks. The Act also introduced qualified mortgages which are mortgages that meet certain requirements acceptable 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. Prime loans are often some of the most profitable loans for sale or secondary market packaging. In the mortgage market, prime loan classification is also a key characteristic for secondary market structured portfolios sold to government sponsored entities including Freddie Mac and Fannie Mae.