What are basis points? A guide to how they affect mortgages

Quick insights

When navigating loan options, you may hear loan providers refer to “basis points.” While the term may sound technical, it plays a significant role in how much you’ll ultimately pay in interest. A basis point, sometimes abbreviated as “bps,” is equal to 0.01%, or one-hundredth of a percentage point (.0001).

In the context of mortgages, basis points are used to express changes in interest rates with greater precision. For example, if a mortgage rate increases from 3.50% to 3.75%, that’s a rise of 25 basis points. Though the change may seem small, even a few basis points can noticeably affect your monthly mortgage payment and the total amount of interest you’ll pay over the life of the loan.

Understanding how basis points work can help borrowers make more informed decisions when buying a home or refinancing.

How do basis points affect mortgage costs?

Mortgage lenders, economists and financial institutions use basis points instead of percentages to communicate small movements in interest rates clearly and precisely. A single percentage point equals 100 basis points, and this unit can help avoid ambiguity, especially when discussing fractional rate changes. For example, saying a rate increased by 25 basis points is much more precise than saying it went up by “a quarter percent,” which can sometimes be misheard or misinterpreted. In the world of mortgages, where even 0.01% can have financial impact, this level of clarity is essential.

Here's how changes in basis points can directly affect your mortgage payments and long-term borrowing costs.

Impact on monthly mortgage payments

Even a small increase in basis points can push monthly payments higher. For instance, a 25-basis point increase (from 6% to 6.25%) on a $300,000 loan with a term of 30 years may raise the monthly payment by roughly $50. That increase may not seem dramatic at first, but it affects homebuying budget and affordability, especially in a rising-rate environment.

Long-term financial implications

Small rate increases translate into significant additional interest over time. Using the same 25 basis point example, that $50 monthly increase adds up to $600 per year, and approximately $18,000 over a 30-year loan term. These costs compound, especially for borrowers who plan to stay in their home long-term or take longer to refinance.

Example calculation

Imagine two borrowers: one locks in a mortgage rate of 6%, while the other ends up at 6.25%. Though the difference is only 25 basis points, the borrower with the higher rate pays thousands more in interest over the life of the loan. An amortization calculator can show how the interest rate affects both the monthly mortgage payment and total interest paid. Experiment to see how even a small change in interest rates can lead to substantial differences in long-term financial costs. These differences can affect long-term financial planning.

Practical tips for monitoring mortgage basis points

Keeping an eye on how mortgage rates shift, especially in smaller increments like basis points, can help borrowers make well-timed and informed decisions. With a few reliable tools and a focus on market activity, it could become a little easier to anticipate changes and plan with confidence. Here are some tips:

In summary

While basis points may seem like a small technical detail, they are important when it comes to mortgage rates and long-term loan costs. A shift of just a few basis points can change monthly payments and add up to thousands of dollars over a repayment term. By staying informed about rate movements and knowing how to evaluate them, borrowers can make more confident and cost-effective choices.