Basis Points: What They Are And Why They Matter

The interest rates on mortgages and other loans often fluctuate frequently, and usually by fractions of a percent. That is why when financial professionals talk about percentages, they often speak in terms of basis points. Financial professionals might use basis points to identify changes in interest rates or financial instruments (meaning money-holding assets like stocks or bonds). Understanding what basis points are and how basis points work can be crucial in making sure that you understand how mortgages work.

What Are Basis Points?

Basis points, also known as BPS or BIPS, are a numerical unit of measurement used to identify rate changes in interest rates, percentages or other financial instruments including the federal funds rate maintained by the Federal Reserve. One basis point equals 0.01%, which is 1/100th of a percent.

Why Do Basis Points Matter?

Basis points are important because they give a common starting point in the discussion of how much rates like interest rates have changed. As an example, while reading about mortgage rates, you might see a sentence like “The Freddie Mac Primary Mortgage Market Survey shows that the average rate on a 30-year fixed with 0.7 points paid in fees fell 3 basis points to 6.97% last week.”

3 basis points translates to 0.03%, which means that if the rate is now 6.97%, the starting rate was 7%.

What Basis Points Apply To

Basis points generally reference interest rates on things like mortgage loans and rates of return on investment. Here’s a list of a few of the things that can be evaluated based on basis points:

• Savings and checking accounts' interest rates
• Personal loans
• Home loans
• Student loans
• Auto loans
• Rates of returns on mutual funds
• Yields on bonds

How To Calculate Basis Points

Remember that one basis point equals to 1/100th of a percentage (0.01%). Divide the basis point number by 100 to turn it into a percentage. Conversely, multiplying the percentage by 100 will give you the basis points number.

If an interest rate drops by 0.5% (such as from 7% to 6.5%), you can also say that the rate dropped 50 basis points. You can also calculate the other way — if a rate went up by 25 basis points, it's the same as saying that the rate increased by 0.25%.

Why Basis Points Matter To Home Buyers

Basis points are often used when talking about mortgage rates. The interest rate on a home mortgage is one of the primary factors that determine the size of a monthly mortgage payment. While it's common to hear about changes in interest rates in terms of percentages, prospective homebuyers should also be aware of basis points. That way, if you hear changes in rates discussed in basis points, you'll understand how that might affect you.

How Basis Points Impact Monthly Mortgage Payments

Even small changes to interest rates can impact the overall cost of a mortgage. Here's one example of how basis points impact monthly mortgage payments:

• A 30-year fixed-rate mortgage for $300,000 at an interest rate of 7% has a monthly payment of $1,996
• Changing the interest rate by only 10 basis points (to 6.90%) drops the monthly mortgage payment to $1,976

How Basis Points Influence Mortgage Lending Processes

Mortgage lenders usually sell their loans to investors on the secondary mortgage market, so knowing when to change their rate and move basis points up or down can mean the difference between a profit and a loss on the mortgage loan. At the same time, the rate can’t be too high because they would need to be competitive with the rest of the market.

Basis Points FAQs

Here are some frequently asked questions about basis points:

Why do they use basis points instead of percentages?

Because interest rates fluctuate frequently and in small fractions of a percentage, it can be more convenient to talk about the changes in rates in basis points rather than percentages. That allows lenders and others in the finance industry to refer to whole numbers (3 basis points) rather than decimals (a change of 0.03%).

How much is 100 basis points?

Each basis point represents one one-hundredth of a percentage point of interest. So, a change of 100 basis points represents a change of 1% in interest. Because interest rates often move in fractions of a percentage point, it's common for rate changes to be expressed in basis points.

Are basis points the same as mortgage points?

While both basis points and mortgage points are related to interest rates, they are not the same thing. A basis point is 1/100th of a percentage point of interest, while mortgage discount points are a type of prepaid interest that lower your interest rate. One mortgage point equals 1% of your total loan. One mortgage discount point typically lowers your mortgage interest rate by 0.25%.

The Bottom Line: Understanding Basis Points Can Help You Save

Basis points are a way people communicate about changes in interest rates, including those for mortgages. A percentage point of interest rate is made up of 100 basis points, which means that each basis point is 1% of a percentage point. It’s important to understand the way this works because when the loan amounts get big enough, changes of a few basis points can mean thousands of dollars in gained or lost returns, or higher or lower interest paid.

If you have a complete view of your financial resources, you can better understand the impact higher interest payments could have on your budget. Understanding and managing the rates on your loans, mortgages and credit cards can help you pay your debts down and ultimately eliminate your debt. Download the Rocket Money℠ app today to get in-depth visibility over your finances.