Basis points (BPS): A complete guide

Understanding your mortgage is key when you’re trying to turn your dream of owning a home into reality. As you may imagine, there’s quite a bit of math involved in calculating your monthly payment – but don’t worry, it’s manageable.

One important piece of this complicated financial puzzle is a basis point. Lenders use basis points to express changes in interest rates, and even a small adjustment can make a noticeable difference in your monthly payment. So when you hear financial experts talk about interest rates going up or down, they may refer to the change in terms of basis points rather than fractions.

Basis points play a critical role in many financial services, but for the purpose of this article we’ll focus on them in conjunction with mortgages.

What is a basis point?

Basis points, also called BPS (pronounced “bips”), are units of measurement that assess percentages in financial situations. Portfolio managers and investors use basis points to indicate the percentage change in interest rates, bond yields, or financial ratios in U.S. Treasury bonds, mutual funds, exchange-traded funds (ETFs), and real estate–based investments.

Professionals use mathematical terms to describe basis points. But you can understand them, too – even if you’re not a financial analyst or banker.

If you’re in the market to buy a house, you’ll likely come across basis points in discussions about your mortgage interest rate. If your interest rate increases or decreases by basis points, your monthly mortgage payment will also change.

So why use basis points instead of percentages? For starters, basis points create a common language that’s easier to understand than percentages, which can be confusing for those who aren’t well-versed in financial minutia.

So, for instance, an interest rate increase of 0.1% may seem like a negligible amount. But when that same figure is described as moving by 10 points, it emphasizes the actual significance of the shift. Because when interest rates fluctuate, even if it’s only by a small amount, it represents an enormous amount of money. This change can then affect the mortgage industry, credit card rates, and other financial instruments.

How much is a basis point?

A basis point is one-hundredth of a percentage point, so one basis point equals 0.01%, or 0.0001. One hundred basis points are equal to 1%.

How are basis points calculated?

Let’s break down the steps for manually calculating basis points. There are two critical steps in this process:

• When converting basis points to percentages, multiply by 100
• When converting percentages to basis points, divide by 100

Let’s do a step-by-step calculation to see the process at work. In the example below, let’s say the interest rate rose 250 basis points in 1 year from a baseline interest rate of 5.5% (or 0.055).

Question: What is the new interest rate?

To find out, remember that one basis point equals 0.0001. So follow these steps:

1. Multiply 250 by 0.0001 (250 × 0.0001 = 0.025), which gets you 0.025.
2. Add that to the baseline interest rate (0.055) to get the new rate: 0.08.
3. Multiply that number by 100 and you get the percentage, which equals a new interest rate of 8%.

In this example, if a loan had a 5.5% interest rate and it increased 250 points, the loan’s interest rate would now be 8%. Keep in mind, this kind of rate jump doesn’t happen at once. It usually takes a few rate hikes (each by a quarter or half percent, typically) over an extended amount of time for a rate to rise 2.5%.¹

Now, let’s say you’re curious about how an interest rate converts to basis points. In that case, you’ll reverse the process. Let’s use the same interest rate of 2.5%:

1. Convert 2.5% to a decimal by dividing it by 100. The calculation is 2.5 ÷ 100 = 0.025.
2. Then, divide this figure by 0.0001 to get 250 basis points.
   

If you want to do more of this type of work, use the Rocket Mortgage mortgage calculator to see how 100 basis points (1%) can change a mortgage payment.

How do basis points work in mortgages?

Depending on your mortgage type, changes in basis points can have a direct impact on your monthly payments. Your mortgage interest rate is the percentage you pay to borrow money from a lender for a specific period of time, so when the interest rate increases, your monthly mortgage payment goes up, as well.

If your mortgage rate is variable, which is the case with adjustable-rate mortgages (ARMs), your interest rate might change depending on market rates. ARM payments may increase at adjustment dates, and basis point hikes will affect your principal amount (the amount you owe) and your interest rate. Let’s say that you have an ARM with an interest rate of 7.5%, then the interest rate changes to 7.75% at a later date. This means your interest rate rose by 25 basis points.

FAQ about basis points

How do basis point changes affect my monthly payments?

It’s important to remember that your monthly payments will only change if you have an ARM. Any payments you make on a fixed-rate mortgage will always remain the same. In other words, all rate changes will depend on your loan terms. Check with your lender for exact information about your payment amounts.

Why does the difference of one-hundredth of a percent matter?

A fraction of a percent doesn’t seem like much, but a hundredth of a point on a mortgage interest rate can mean tens of thousands of dollars over the life of the loan.

Paying attention to basis points – which may seem like tiny numbers – can help you save a lot of money when you’re buying a home.

The bottom line: Just a few basis points make a big difference

When you’re working toward the dream of owning your own home, no detail is too small. Basis points play an important role in your mortgage – and ultimately, your financial future.

As with many things, knowledge is power. The more you understand how basis points affect your loan, the better prepared you’ll be to make smart decisions.

Ready to start the home buying journey? Check out how Rocket Mortgage can help you find a home of your own today!

¹Interest rate and APR examples leveraged in the article are for educational and illustrative purposes only.

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