Federal Discount Rate vs. Fed Funds Rate vs. Prime Rate
By Markets & Investing DeskUpdated Nov 10, 2026
Definition
The federal discount rate is the interest rate a Federal Reserve Bank charges banks and other depository institutions that borrow directly from the Fed through its discount window.
Key takeaways
- Each of the 12 Reserve Banks sets discount rates at least every 14 days, subject to Board of Governors review.
- Secondary credit carries a penalty rate, historically 50 basis points above the primary credit rate.
- Since March 2020, the primary credit rate has been set at the top of the fed funds target range.
- The usual order from lowest to highest is fed funds, then primary credit, then secondary credit, then prime.
The federal discount rate is the interest rate a Federal Reserve Bank charges a bank or other depository institution that borrows directly from the Fed through its discount window. The federal funds rate is the rate banks charge each other for overnight loans of reserves. The FOMC sets a target range for it, and the market sets the actual rate inside that range. The prime rate is the rate commercial banks charge their most creditworthy business customers, and banks use it as a base for many consumer loans.
What the Federal Discount Rate Is and How It Works
The Fed acts as the banking system’s lender of last resort. When a sound bank needs cash on short notice and cannot raise it cheaply in the market, it can borrow from its regional Federal Reserve Bank against collateral. This lending channel is the discount window, which is also described as a standing lending facility. The rate charged on these loans is the discount rate.
Each of the 12 Reserve Banks establishes its discount rates, subject to review and determination by the Board of Governors. The Federal Reserve Act requires the Reserve Banks to set these rates at least every 14 days. In practice, the rates move together across Reserve Banks.
In normal conditions banks borrow very little at the window. Funding from other banks or from deposits is cheaper, and many banks have been reluctant to use the window because borrowing could signal weakness. This reluctance is known as discount window stigma. The window matters most when interbank markets tighten and an otherwise healthy bank needs liquidity to avoid failing.
The Three Types of Discount Window Rates
Primary credit. This program is for depository institutions in generally sound financial condition. Loans are usually overnight, although longer terms have been offered at times. The primary credit rate is the figure people mean when they say “the discount rate” or “the primary discount rate.”
Secondary credit. This program is for institutions that do not qualify for primary credit, typically banks with financial problems or severe liquidity strain. The Fed charges a penalty rate that is set above the primary credit rate, historically 50 basis points (0.5 percentage points) higher, and it monitors these loans more closely.
Seasonal credit. This program serves smaller institutions, often in agricultural or resort communities, whose loan demand and deposits swing predictably over the year. It is not emergency lending. The seasonal rate is tied to market rates rather than set as a fixed spread over primary credit.
The Federal Funds Rate
Banks hold reserve balances at the Fed. A bank with more reserves than it needs can lend them overnight to a bank that needs more, and the interest charged on those loans is the federal funds rate. Historically this market helped banks meet reserve requirements. The Fed reduced reserve requirement ratios to zero in March 2020, but the fed funds market still exists and remains the Fed’s main policy benchmark.
The Federal Open Market Committee (FOMC) sets a target range for the rate, usually 25 basis points wide. The rate banks actually pay is published as the effective federal funds rate, which is a volume-weighted median of overnight trades. The Fed keeps that rate inside the target through administered rates, mainly the interest it pays on reserve balances and its overnight reverse repurchase facility. It also uses open market operations in Treasury securities. The discount rate sets a ceiling of sorts: a bank has little reason to pay much more than the primary credit rate in the market when it could borrow from the Fed instead.
The Prime Rate
The prime rate is a private benchmark. Each commercial bank sets its own prime rate, but the widely quoted U.S. figure follows a long-running convention: the federal funds target (now the upper bound of the range) plus 3 percentage points. When the FOMC moves its target, major banks usually adjust prime the same day or the next.
Prime matters to households because many variable-rate products are priced as “prime plus” a margin, including credit cards, home equity lines of credit and some small business loans. Banks charge borrowers more than the Fed’s rates because a bank’s funding cost is roughly tied to fed funds, and its customer rate adds a spread for credit risk, operating costs and profit.
Federal Discount Rate vs. Fed Funds Rate vs. Prime Rate: How They Line Up
| Discount rate (primary credit) | Federal funds rate | Prime rate | |
|---|---|---|---|
| Who lends | Federal Reserve Bank | Another bank | Commercial bank |
| Who borrows | Eligible depository institution | Bank | Business or consumer customer |
| Who sets it | Reserve Banks, with Board of Governors determination | Market, within an FOMC target range | Each bank, by convention from the fed funds target |
| Typical term | Overnight (longer at times) | Overnight | Base rate for ongoing loans |
| Role | Backstop liquidity | Main policy benchmark | Consumer and business loan pricing |
The usual order from lowest to highest is fed funds, then primary credit, then secondary credit, then prime.
Worked Example (Hypothetical)
Suppose the FOMC sets a fed funds target range of 4.25% to 4.50%. These figures are illustrative and are not current rates.
- The effective fed funds rate trades inside the range, for example 4.33%.
- If primary credit is set at the top of the range, as it has been since 2020, the primary credit rate is 4.50%.
- Secondary credit at 50 basis points above primary would be 5.00%.
- Prime at the upper bound plus 3 points would be 7.50%.
- A home equity line priced at prime + 1% would charge 8.50%.
Now assume a bank borrows $100 million overnight. At the effective fed funds rate of 4.33%, one night’s interest is about $100,000,000 × 0.0433 ÷ 360 ≈ $12,028. Money market loans in the U.S. use an actual/360 day count. At the 4.50% primary credit rate, the same loan costs about $12,500. The roughly $472 gap is small for one night, but together with stigma it explains why banks go to the market first.
If the FOMC cut the target range by 25 basis points, every figure in the chain above would usually fall by about the same amount. That pass-through is how a Fed decision shows up in a credit card or HELOC rate within a billing cycle or two.
Why the Discount Rate Is Set Higher Than the Fed Funds Target
The primary credit rate is generally set above the fed funds target, or at its top. The Fed wants banks to borrow from each other first, because lenders in that market judge each other’s credit and liquidity. A higher discount rate keeps the window as a fallback rather than a cheap first choice.
The size of the gap has changed over time. When the current primary credit program began in 2003, the rate was set 100 basis points above the fed funds target. The Fed narrowed the spread during the 2007 to 2008 financial crisis. In March 2020 it moved primary credit to the top of the target range to encourage banks to use the window.
How the Fed Uses These Rates
The FOMC raises or lowers its fed funds target to cool or support the economy, and the discount rate is adjusted alongside it. When inflation runs high, as measured by indicators like the Consumer Price Index, higher rates make borrowing more expensive and slow credit growth and spending. When the economy weakens, lower rates make credit cheaper and encourage borrowing and investment.
Of the three rates, the fed funds rate has the broadest reach: short-term market rates, bank deposit and loan rates, and prime itself key off it. The discount rate caps funding costs and keeps sound banks liquid in a crisis. Longer-term rates such as 30-year mortgage rates do not move one for one with either rate, because they also reflect expectations about inflation and future policy.
Limitations and Common Confusions
- Not the rate in headlines. When news reports say the Fed is raising rates, they mean the fed funds target range, not the discount rate.
- Not the finance discount rate. In valuation, a discount rate is the return used to convert future cash flows into present value. The concept is unrelated.
- Low usage does not mean low importance. Discount window lending is small in normal times but can grow quickly during stress, as in 2008, 2020 and 2023.
- Prime is not a Fed rate. Banks set it by convention from the fed funds target, and a lender can quote its own prime.
- Real versus nominal. All three are nominal rates. Subtracting inflation gives the real rate, which can be negative when inflation exceeds the policy rate.
FAQs
Where can I check the current discount and fed funds rates?
The Federal Reserve publishes discount window rates on its discount window site and in its H.15 statistical release. The release also reports the effective federal funds rate and the bank prime loan rate. The FOMC's target range is stated in each post-meeting statement.
The Bottom Line
The discount rate matters most to banks that need emergency liquidity and to anyone following how Fed policy reaches loan pricing. Banks borrow from each other first because market funding is cheaper and window borrowing carries stigma. For households, the fed funds target drives the prime rate, which sets the cost of credit cards and home equity lines, while the discount rate acts as a backstop and a cap on bank funding costs.
