What is a Basis Point (BPS) and How Are They Used?

What is a Basis Point (BPS) and How Are They Used?

Understanding basis points can allow you to determine the monthly mortgage payment of a home, as well as the changes in interest rates associated with purchasing a home. This can give the home-buyer the ability to be much more financially informed before the purchase of the said new home.

What Are Basis Points?

Basis points are financial tools that are used to assist managers of portfolios along with financial investors, with mutual funds, exchange-traded equities, and treasury bonds, to find out the change as a percentage in interest rates and/or financial ratios. While basis points are used primarily by financial professionals, they can also be utilized and understood by home-buyers and homeowners as well, with proper explanation and instruction.

How Much Is A Basis Point?

Often referred to as “bps”, basis points are the equivalent of .01% (.0001) per basis point. They can be used to show the changes in interest rates in an instrument of finance. While a percentage as small as .01% may seem minuscule at first glance when considering the total price of a home and monthly payments it will show you a much larger number than you may initially expect. For instance, a jump of one hundred basis points would take payment from 3% to 4%, and 1% of your mortgage may be a hefty amount depending on the original value.

Turning Basis Points To Percentages

Using the example of a change in a monthly interest rate from 3% to 4%, you can more distinctly comprehend the change by stating that the interest rate changed by a total of 100 basis points, instead of 1%. Noting that each basis point is, in fact, worth .01%, one can effectively transfer the number of basis points into a percentage by multiplying your amount of bps by the value of one basis point, then multiplying that number by 100, which will give you your basis point percentage. We could, for example, use 300 basis points. First, we would multiply 300 by .0001 (300 x .0001 = 0.030) giving you 0.030. We would then multiply this by 100 (0.030 x 100 = 3) giving you your basis point percentage conversion of 3%.

Mortgage and Effects of Basis Points

Depending on the type of mortgage one may have, basis points can affect your monthly mortgage payments either positively, or negatively. With an increased interest rate, the monthly mortgage payment will increase as well. This interest rate is how much you pay (a percentage of the full amount) to take a loan out from a bank or financial institution, over a specified length of time. Understanding basis points in this situation will allow you to determine with much greater detail how much more or less you will be paying monthly in the event of a change in the interest rate applied to your mortgage.

Basis Point Calculation

Basis Point Calculation

When determining the number of basis points an interest rate percentage signifies, we would simply reverse the aforementioned formula which was used to find the interest rate percentage shown by a given amount of basis points. This is done by taking an initial interest rate and changing this to a decimal by dividing it by 100. We will use the interest rate of 3.25% for this example. First, you would divide 3.25 by 100 (3.25/100 = 0.0325) giving you 0.0325 as your decimal. Then, you would divide this by 0.0001 (0.0325/0.0001 = 325) giving you 325 basis points.

All Things Considered

Given the equations and information provided thus far, one should now have the ability and tools necessary to determine the changes in percentages and basis points in mortgages, and how to find and calculate these as well. We have learned the function of basis points, the way they can affect mortgage payments, and how they increase/decrease with interest percentages. Whether you are shopping for a new home, or you are managing an already-purchased home payment, a few of these key points will help you to gain a greater comprehension of basis points and their purposes as well as uses, such as knowing how to calculate basis points, understanding that 100 basis points are the equivalent of 1% when shown as an interest rate, having the formulas available for you to calculate and determine both basis points and interest rates, and knowing how these things will affect your overall cost and payments on a mortgage.

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