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What Is a Basis Point? Why It Matters on Your Mortgage

March 25th, 2018 10:48 PM by Jackie A. Graves, President

You probably won’t get very far in your mortgage learning process without hearing the term “basis point,” so let’s take a look at what this term means and why it matters on your mortgage.

It’s Just Industry Jargon

A basis point is a mortgage (and overall financial services industry) term to describe differences and changes in interest rates.

One basis point is one one-hundredth of a percent, or 0.01 percent.

Therefore one hundred basis points is one percent.

So if you got a mortgage rate quote of four percent one week and it changed to 4.25 percent the next week that means it rose by 25 basis points.

The abbreviation for plural usage “basis points” is bps (pronounced “bips”), so in the example above you could say your quote rose by 25 bps.

Why So Precise?

Why is there a need to look at rates all the way down to hundredths of a percentage point? The short answer is that every penny counts when you’re talking about a large loan like a mortgage.

To illustrate the point, let’s take a closer look at the two different forms in which rate quotes are delivered:

  • Your quoted rate. This is the actual rate of interest you pay on your mortgage, and mortgage lenders typically quote in increments of .125 percent, also known as “eighths.” Each eighth is 12.5 basis points, and on a $300,000 loan, each 12.5 basis point increment up or down changes your monthly principal and interest payment by $22 (and changes your monthly interest cost by $31).
  • Annual percentage rate (APR). This is an expression of what your rate would be if all closing costs were incorporated into the rate, and Federal Truth In Lending laws [LINK TO “TRUTH IN LENDING ACT’ MEC PIECE] require an APR disclosure to appear on all rate quotes. Because APRs incorporate line item costs, they are almost always disclosed with three decimal places to be as specific as possible. Basis points come in handy when you’re comparing APRs from lender to lender. If you got four-percent rate quotes from two lenders, and one had a 4.031 percent APR and the other had a 4.011 percent APR, the difference of two basis points is a strong indication that both lenders’ closing cost line items will be very close once you see them. However, if your APRs were 4.031 percent and 4.161 percent on the same four-percent rate quote, you’d know the APR that’s 13 basis points higher will ultimately have higher closing-cost line items.

Quick Reference Jargon Translator

Because rate quotes mostly move in increments of one-eighth, here is a quick reference to translate eighths to basis points, so you can easily translate any industry jargon you hear.

Fraction

Percent

Basis Points

One eighth

0.125%

12.5

Two eighths (or one quarter)

0.25%

25

Three eighths

0.375%

37.5

Four eighths (or one half)

0.5%

50

Five eighths

.625%

62.5

Six eighths (or three quarters)

.75%

75

Seven eighths

.875%

87.5

Eight eighths (or one)

1%

100

 

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Posted by Jackie A. Graves, President on March 25th, 2018 10:48 PM

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