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What Are Basis Points in Mortgages?

TLDR

What You Need To Know

  • Basis points are used in the mortgage industry to indicate a change in interest rates
  • One basis point equals 0.01%, and 100 basis points equal 1%
  • Basis points can have a significant impact on how much interest you pay over the life of a mortgage loan

Contents

If you’re in the process of getting a mortgage or just want to know all you can about the home buying process, you’ll want to get familiar with basis points. Basis points can impact your mortgage rate, which will impact how much interest you pay over the life of your loan. 

We’ll give you the lowdown on what basis points are, what they do to interest rates and how they can affect your monthly mortgage payments.

What Are Basis Points?

The mortgage industry uses basis points to describe changes in interest rates or when comparing rates. 

Basis points (also known as bps and pronounced as “bips” or “beeps”) are fractions of a percentage. 

Each basis point equals 0.01% (or one one-hundredth of a percent). One hundred basis points equal 1%. For example, if your interest rate is 4.5% and it goes up by 25 basis points, to calculate the new rate, you add 0.25% to 4.5%. That would give you a new rate of 4.75%.

To convert an interest rate to basis points, you do the same calculation in reverse. If the interest rate is 4.5% and the rate increases to 4.625%, then it went up by 125 basis points.

What’s the point of using basis points instead of percentages?

Are you wondering why we can’t just say 1% instead of 100 basis points? 

First, you’d miss out on the pleasure of blurting out “bips” or “beeps” during mortgage loan conversations. And second, basis points clarify exactly how much an interest rate has changed. Basis points make the number you’re talking about clearer for the lender and the borrower. Basis points are a fixed number, while a percentage is a ratio. 

Using basis points makes the math easier. Let’s say you have a 1% increase on a 4% interest rate. That means the rate would go from 4% to 4.04%. Some people could also interpret that as a rate increase from 4% to 5%. To avoid confusion you can just say “The interest rate increased by 4 bps, so the new rate is 4.04%.”

How Do Basis Points Affect Mortgage Rates?

A fraction of a percentage may not seem like much, but over the life of a loan, it can amount to thousands. We’ll show you.

Let’s say you’re looking to get a 30-year fixed-rate mortgage loan for $100,000. Because the interest rate is locked in (or fixed) for the life of the loan, your monthly loan payments never change. 

Now you get the loan, and it comes with a 3.75% interest rate. Your monthly loan payment, not including taxes, fees and insurance, is $463.12. 

Let’s say you don’t lock in your interest rate with the lender, and the rate goes up by 25 basis points (or 0.25%). Your interest rate jumps to 4.0% and now your monthly payment is $477.42. 

Over the course of a 30-year loan, you’ll pay $7,200 more in interest with a 4.0% interest rate  ($19,880 in total) than with a 3.75% interest rate ($12,680 in total). FYI: This is a good reason to consider locking in your interest rate.

How Do Basis Points Affect Adjustable-Rate Mortgages?

If you have an adjustable-rate mortgage loan (ARM), also known as a floating mortgage, your interest rate is fixed during the introductory period (which typically ranges from 1 – 10 years).[1] After the introductory period, your rate can go up or down every month, quarter, year or every few years. The rate will reset according to the terms of your loan.  

Most ARMs have caps on how high or low the mortgage rate can go and how often it can change. 

Let’s say you’ve found your dream home and a lender, and you take out a 5/1 ARM. A 5/1 ARM is a 30-year mortgage loan with a fixed rate for the first 5 years and an annually adjustable rate for the remaining 25 years. 

Your $200,000 mortgage comes with an introductory 4.0% interest rate. For the first 5 years, your monthly mortgage payment, minus taxes, fees and insurance, will be $954.83.

After the 5-year intro period, let’s say the interest rate rises by 25 basis points. Now your mortgage payment becomes $983.88. If it adjusts up 25 basis points a year after that, you’ll have an interest rate of 4.5% and a monthly loan payment of $1,013.37.

Basis Points vs. Mortgage Points

It can be easy to confuse basis points with mortgage points (aka mortgage discount points). But they are not – we repeat – not the same thing. 

In real estate, basis points express a percentage change in interest rates.

Mortgage points, on the other hand, let you purchase a lower interest rate on your mortgage loan. 

But … if you wanted to nerd out for a hot sec, you could describe the rate reduction in basis points! One mortgage point reduces your interest rate by 0.25%. That’s – you got it – 25 basis points.

Got the Basics of Basis Points?

Now that you know what basis points are and how they can affect your loan, you’re in a better position to understand what lenders are talking about as you shop around for rates and look for that new home.

  1. The Federal Reserve Board. “Consumer Handbook on Adjustable-Rate Mortgages.” Retrieved January 2022 from https://files.consumerfinance.gov/f/201204_CFPB_ARMs-brochure.pdf

ICYMI

In Case You Missed It

  1. Basis points are a good way to talk about small changes in interest rates

  2. If you have an adjustable-rate mortgage (ARM), basis points can have an especially big effect on the rate when it changes

  3. Mortgage points, which are used to purchase a lower interest rate, are not the same thing as basis points

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