Buying or refinancing a home can be an exciting time, but don’t let it divert you from the details. Understanding how basis point changes affect your loan interest rate will help you become a wiser consumer and may even save you money. Here is what you need to know.
What Are Basis Points?
Basis points are used by the Federal Reserve Board and the financial industry to express a change in interest rates or bond yields (we’ll stick to interest rates here). One basis point equals 1/100 of a percent (0.01%). To find the equivalent change in the interest rate, simply multiply the number of basis points by 0.01% (e.g., 22 basis points x 0.01% = 0.22%; 100 basis points x 0.01% = 1%).
Here are some illustrations:
- A loan rate of 3.99% is the equivalent of 399 basis points.
- As of January 2015, the prime rate as reported by The Wall Street Journal was 3.25%. If the rate were to go up 1 basis point, it would increase to 3.26%. If it were to go up 50 basis points, it would increase to 3.75%. A 100-basis point increase would result in a 4.25% rate.
- If a loan rate is 5% and goes up 20 basis points, that is the equivalent of raising the interest rate by 0.2%, or a resulting rate of 5.2%.
- If interest rates are at 4.75% and drop to 4.6%, that is a 15-basis point (0.15%) decrease.
Why Basis Points Matter
Although a basis point seems small, even a modest change can make a big difference in the total interest you pay over the long term. Here is a chart showing how total payments on a $200,000 loan change, based on a 30-year fixed mortgage of 3.75% and 10-, 20-, and 50-basis point increases.*
|Interest Rate||Basis Change from 3.75%||Monthly Payment||Total Paid||Total Interest Paid|
*Rates are for example only. Your rate will depend on current mortgage rates plus your credit history.
What Is the Difference Between Basis Points and Discount Points?
Don’t confuse discount points (often just called points) with basis points. A discount point equals 1% of the loan amount. For example, a point on a $200,000 loan would equal $2,000.
When you pay discount points, you’re essentially prepaying some of the interest on a loan. The more points you pay at closing, the lower the interest rate will be over the life of the loan. This can help make monthly payments more affordable and save money in interest over the long term. Whether it’s worthwhile to pay for discount points depends on the loan rates available and how long you plan to stay in the home.