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A basis point (BPS) is a standardized unit of measurement equal to 0.01%, or one-hundredth of a percentage point. For homeowners and buyers, even a small change of 25 to 50 basis points can significantly impact monthly mortgage payments and the total interest paid over the life of a loan. Understanding this financial term empowers you to better evaluate rate changes, whether you're locking in a rate at closing or managing an adjustable-rate mortgage.
Lenders use basis points to communicate interest rate changes with precision. This avoids the ambiguity that can come from discussing fractions of percentages. Since mortgage rates are quoted in percentages, even a tiny fluctuation can represent a substantial cost difference over a 30-year loan. One basis point (1 bps) equals 0.01%. Therefore, a change of 100 basis points is equivalent to a 1% change in the interest rate.
For example, if your lender says your interest rate increased by 25 basis points, it means your rate rose by 0.25%. A rate moving from 4.00% to 4.25% is a 25-basis-point increase.
The calculation is straightforward and involves simple conversion.
Applying this to a real scenario: Assume you have a variable interest rate of 6.5%, and the index it's tied to increases by 50 basis points. To find your new rate:
Your new interest rate would be 7.0%. The table below illustrates common conversions for quick reference.
| Basis Points | Percentage |
|---|---|
| 1 | 0.01% |
| 10 | 0.10% |
| 25 | 0.25% |
| 50 | 0.50% |
| 100 | 1.00% |
The impact of a basis point change depends heavily on your type of home loan.
Fixed-Rate Mortgages: The interest rate you secure at closing, detailed in your Closing Disclosure, is fixed for the entire loan term. Basis point fluctuations in the market after you close do not affect your payment. Your principal and interest payment remains unchanged.
Adjustable-Rate Mortgages (ARMs): These loans start with a fixed introductory rate for a set period (e.g., 5 or 7 years). After this period, the rate adjusts periodically based on a pre-defined financial index plus a margin. These adjustments are almost always communicated in basis points. A change of 50 or 100 basis points at the first adjustment period can lead to a noticeable increase in your monthly payment.
The financial impact of a rate change is directly proportional to your loan amount. Using a mortgage of $400,000 as an example, we can see the effect of a significant adjustment, which is common with ARMs.
This 300-basis-point increase results in a monthly payment that is $788 higher. Over a year, that adds up to nearly $9,500 in additional interest costs. Borrowers who anticipate their income rising may be able to manage this increase, but for those on a fixed income, it could create financial strain.
When considering a mortgage, it is crucial to understand not just the initial rate but also the potential for future payment changes. Based on our experience assessment, carefully reviewing the loan terms for adjustment caps and frequency is essential for long-term budgeting.
