If you’re in the process of purchasing a home you will most likely hear about basis points in mortgages at one point or another through the loan process. It’s an important part of your mortgage to understand because it impacts the overall cost of your mortgage as well as your monthly payment.
- A single basis point is equal to 1/100th of 1%, or 0.01%
- Basis points are also used when calculating changes in interest rates for investment products
- Basis points in mortgages are the core measure of changes in lending rates
What are Basis Points in Mortgages ?
A “basis point” in mortgages is a term that represents a single unit of measure for interest rates and percentages. A single basis point is equal to 1/100th of 1%, or 0.01%. In mortgages, basis points are used to show changes in lending rates. It’s popular jargon that is used by lending institutions to notify customers or counterparties of how much their lending rates have increased or decreased.
1 basis points = .01%
Basis points are also commonly referred to as “bips” and are abbreviated as bp or bps. In addition to being used in the mortgage industry, basis points are also used when calculating changes in interest rates for investment-related products.
Basis Points Table
As you can see basis points are a very granular metric and this is due to the large impact they have on mortgages. As such, it’s important to understand their incremental nature to get an accurate idea behind their changes. A change in basis points will also impact the prepaid interest on a mortgage.
Who Do Basis Points Impact?
In mortgages, basis points have the greatest impact on borrowers. For example, let’s assume you’re shopping around for mortgages and are comparing two different lenders.
- Lender 1 offers you a 30-year fixed rate mortgage at 3.5%
- Lender 2 offers you a 30-year fixed rate mortgage at 3.75%
In this scenario, we can see that Lender 1 offers you a mortgage that is 25 basis points better than Lender 2. As a result, you decide to with Lender 1 for your mortgage.
However, they do also impact lenders and their ability to provide competitive lending rates to their customers. It’s important to know that lenders mark up their mortgage rates based on changes in the Fed Funds rate. Depending on the business model of the lender, some lenders will naturally have lower rates than others, but they will never offer rates lower than the Fed Funds rate.
Basis Points and the Fed Funds Rate
At a basic level, the federal funds rate is the interest rate at which banks and other financial institutions lend money to each other. The federal funds rate is subject to change 8 times per calendar year and is managed by the FOMC.
The basis points function as their unit of measure and represent changes in interest rates. These changes have a large impact on the money supply and inflation. In mortgages, basis point changes are an extremely important metric to pay attention to if you plan on purchasing a house.
Basis Point Example
For example, let’s assume that the current Fed funds rate is set to 2.5%. The FOMC decides that they will raise rates by 50 basis points. This means that the new Fed funds rate is now 3%. This has a trickle-down effect throughout the economy and one of the biggest industries affected by basis points changes is the mortgage industry.
An increase in the Fed funds rate typically prompts mortgage lenders to increase the rates at which they offer a mortgage to their clients.
Basis Point Calculation
If you want to convert percentages to basis points or convert basis points to percentages, take a look at the following example below:
- Percentages to basis points – multiple the percentage by 100
- Basis points to percentages – divide the points by 100
This is a quick and easy way to convert basis points or percentages to get a different perspective on interest rate changes.
What Other Financial Instruments Do Basis Points Impact?
As we previously mentioned, basis points are also used to measure interest rate changes in different financial products. Below are some of the most popular investment vehicles that are impacted by basis points changes.
- Interest Rate Derivatives
- Mutual Funds
- Credit Derivatives
- Mortgage Backed Securities
How Much is 50 Basis Points?
A 50 basis points increase is equivalent to 0.50% . So if the interest rate changed from 1.5% to 2%, this is considered an increase of 50 basis points.