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If you’re in the process of taking out a mortgage or just want to know everything there is to know 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?
A basis point or bps (pronounced “bips”) is equal to 0.01%, one one-hundredth of a percentage point or 0.0001 expressed as a decimal. We’ve added this chart to show you how basis points convert to percentages and decimals.
|Basis Points (bps)||Percentage Points||Decimals|
Basis points are used across the financial industry to calculate percentage changes in interest rates for everything from Treasury bonds to mutual funds, bond ETFs and mortgages.
Why use basis points vs. percentage points?
Wondering why you can’t just say 1% instead of 100 bps? Basis points clarify exactly how much an interest rate has changed. Using basis points makes the math easier for lenders and borrowers because basis points are fixed numbers, not ratios like percentages.
How do basis points affect adjustable-rate mortgages?
If you’re making payments on a fixed-rate mortgage, you don’t have to worry about bps because the loan’s interest rate is locked in (or fixed) for the life of the loan. Your monthly loan payments will never fluctuate as a result of changing interest rates.
The interest rate on an adjustable-rate mortgage (ARM) is only fixed during the loan’s introductory period. After the intro period, the loan’s rate will reset periodically (go up or down) according to the loan’s terms, which may be every month, quarter, year or every few years.
Let’s say you take out a 5/1 ARM. The “5” indicates that you’ll pay a fixed rate for the first 5 years of the loan. Let’s say you qualify for a 5.25% interest rate for the first 5 years, and your interest rate rises by 25 bps or 0.25% in year 6 (think: the first year the loan is eligible for an annual readjustment, the “1” in 5/1), your interest is now 5.5% and your new mortgage payment will go up as well.
What Are Basis Points vs. Mortgage Discount Points?
Basis points are often confused with mortgage discount points (aka mortgage points). But they are not – we repeat – not the same things.
Basis points are a unit of measure of change in interest rates. Mortgage discount points are purchased from your lender to lower the interest rate on your mortgage. This can save you money in interest, but will cost you more money upfront.
The cost of mortgage discount points may vary by lender. Typically, 1% of your loan amount buys one point, which will lower your interest rate by 25 bps or 0.25%.
Got the Basics of Basis Points?
You’ll encounter plenty of jargon as you delve deeper into the world of mortgages. Now you can add “basis points” or “bips” to your growing finance-speak vocabulary.
Knowing what basis points are and how they affect mortgage loans will put you in a better position as you shop around for favorable rates and look for a new home.