Basis Points (BPS): Definition And How They Are Calculated

If you're reading financial analysis or trying to figure out which mutual fund to invest in, you may come across a variety of terms. However, at the end of the day, when deciding what loan to take over or where to put your money, it all comes down to percentages. But when financial professionals talk about percentages, they often speak in terms of basis points.

Basis points, also known as BPS or BIPS, are numerical units used to identify changes in interest rates, percentages or financial instruments, meaning money-holding assets like stocks or bonds. One basis point equals 0.01%, which is 1/100th of a percent or 0.0001.

Talking in terms of basis points gives a common starting point in the discussion of how much rates have changed. As an example, 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 3.97% last week.” That means that the starting rate was 4%.

On occasion, you may hear professionals pronounce it as “bips” or “beeps.” If you hear that, they may be speaking about basis points.

Basis points are a good example of jargon that’s used in investor and lender circles to avoid communication errors around percentages and decimal points. Considering 1 basis point will always be equal to 0.01% or 1/100th of a percent, a basis point becomes a universal measurement and eliminates any ambiguity when it comes to calculating interest rates across various financial instruments.

Basis points serve as units of comparison for various financial instruments. They show the change or difference within and across different funds or loans. You can measure movements over time in terms of these basis points.

They’re particularly useful when the difference is less than a percentage point. Although it doesn’t sound like much, when the sums being invested or borrowed are big enough, a few hundredths of a percentage point can suddenly make a big difference.

Speaking in terms of basis points also helps avoid fractions or decimals. The Federal Reserve sets the fed funds rate, a range that determines the cost for banks to borrow money from each other overnight. The most recent range is listed as 0% – ¼%. But investors who track these movements can frame the daily ups and downs in terms of a range of 25 basis points.

What Instruments Does BPS Apply To?

Basis points generally reference interest rates and rates of return on investment. Here’s a brief noncomprehensive list of things that can be evaluated based on basis points:

• Interest rates on savings, checking and other accounts
• Loan evaluation for personal loans, mortgages, student loans, auto loans, etc.
• Historical rates of return on mutual funds and other retirement investments
• Yields on things like bonds and treasuries
• Evaluating past performance to trade in stocks, options or futures

1 basis point equals 0.01% or 1/100 of 1%, so if you’re adding 25 basis points, move the decimal over to the left twice so it turns into 0.25%. Or if you’re trying to figure out many BPS 0.45% is, move the decimal point over to the right twice and you get 45.

There's also a metric around the price value of a basis point. This is intended to measure how much the price of the bond moves given a shift in interest rates. You can also use a basis point calculator to convert basis points into a percent or decimal. However, it's also easy to do this yourself.

If you're trying to convert decimal points to a percentage, you move the decimal point two places to the left, so 50 basis points is 0.5%. To convert it back to basis points, you move the decimal point two places to the right.

To get to the decimal value of a basis point, you move the decimal point back four places to the left, so 100 basis points is .01. If you want to convert that into a percentage, you move the decimal back two places to the right from the decimal value. Going back to basis points would require moving the decimal four places to the right of the decimal value. Check out the table below for examples.

The advantage of using basis points over percentages has to do with the fact that it’s a distinct figure that remains constant as compared to a ratio. If I said that the price of a candy bar had increased 25%, that doesn’t tell you everything you need to know. 25% relative to what? Is that a dollar or $10?

Basis points give you a form of absolute. No matter how much money is invested or the size of the loan, you can say the price or yield has gone up by 50 basis points and investors will know what that means.

For those getting a mortgage, it can be helpful to think of the pricing in terms of basis points. All mortgage rates are set based on basis points.

As an example, if you can get a 30-year fixed mortgage at 4%, that’s 400 basis points. If conditions in the market change and rates go up the 5 basis points, that rate is now 4.05%.

Because mortgage lenders need to trade their loan to investors on the market, 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 loan. At the same time, the rate can’t be too high because you need to be competitive with the rest of the market.

It’s also important to note that adjustments of a few basis points are more important to the lender than they should be to you as the borrower. The reason for this is that assuming there’s no prepayment penalty, you can pay off the loan whenever you want prior to the end of the term. Given that, you can save quite a bit on interest over the life of the loan by paying it off early.

Do Basis Points Affect The Mortgage Lending Process?

Mortgage payments are impacted by your interest rate. If there’s a 15-basis-point increase in mortgage rates, there’s a corresponding rise in what your mortgage payment would be. If there is a decrease, your mortgage payment decreases.

If you would like a lower rate and you can make a lower payment in addition to your down payment, you can pay for mortgage points, which are prepaid interest. One point is equal to 1% of the loan amount, but you can buy them in increments down to 0.125 points.

On the other hand, if you’re trying to lower closing costs, you can take a lender credit, which in effect is negative points. In exchange for the lender covering some of the closing cost, you pay a slightly higher rate. 

Will My Monthly Payments Change Constantly?

Your monthly payments will depend on the type of mortgage you take out. For fixed-rate mortgages, your monthly payments will remain the same throughout the lifetime of the loan (excluding taxes and insurance). For adjustable-rate mortgages, or ARMs, your monthly payments will be affected by fluctuating rates.

An ARM has a fixed interest rate for an initial period of time, which varies depending on your loan terms. After that, your rate could go up or down depending on the current benchmark or index rate, plus whatever your lender adds on by way of an ARM margin.

Compare this to interest-only mortgages where you start off with a fixed or adjustable low introductory payment period during which you’re only paying off interest from your loan. After this period is over, you’ll need to make larger payments that incorporate the principal balance.

Not all interest-only mortgages work this way. Some have a balloon payment at the end, so make sure you know what you’re getting into. Rocket Mortgage® doesn’t offer interest-only mortgages at this time.

How Important Can A Hundredth Of A Percent Be?

Let’s say you wanted to buy a home that’s worth $300,000 (with 20% down).  You have the options to get a mortgage rate that’s either 3.24% or 3.25% on a 30-year conventional loan. With the lower rate, you’ll pay $1,043.18 per month and $135,544.23 in interest throughout the lifetime of the loan.

By going up a single basis point, your monthly payment increases a little more than a dollar per month, which doesn't sound like much, but you end up paying approximately $550 more in interest over the life of the loan.

Although we're talking in terms of the base interest rate at this point, it's also important to take into account the annual percentage rate (APR) because this includes closing costs.

Basis points are a way people communicate about changes in interest rates, including those for mortgages. 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.

Are you curious to know more about how interest rates work? Check out our article on the prime rate.