Basis Point in the Mortgage

Introduction

People commonly use mortgages to purchase a home. Borrowers are often quoted interest rates based on basis points when obtaining a mortgage.

Define Basis Points

A basis point is a measure commonly used in finance to describe interest rate changes, bond yield, and other financial instruments. One basis point equals one-hundredth of a percentage point or 0.01%.

Basis Points in Mortgage Explained

Mortgage interest rates are typically expressed in terms of basis points. If a borrower takes a loan on a 30-year fixed-rate mortgage, then the interest rate may be 4.25% plus 50 basis points. This means the total interest on the mortgage is 4.75%.

Basis points are used in mortgages because they provide a more precise way to express changes in interest rates. If the lender in the above example were to increase the interest rate by 0.01%, the interest rate is increasing by 1 basis point. This calculation helps lenders and borrowers to keep track of their payments.

Conversion of Basis Points to Percentage

To convert basis points to a percentage, you simply divide the number of basis points by

100. If you have an interest rate of 50 basis points, you divide 50 by 100 to get 0.50%. Similarly, if you have an interest rate of 200 basis points, you would divide 200 by 100 to get 2.00%.

Impact of Basis Points in Mortgage

Basis points can have a significant impact on mortgage rates and payments. A borrower who secures a $200,000 mortgage at 4.25% interest will have a monthly payment of $983.88 (without taxes and insurance). The monthly payment would rise to $1,043.29 if the interest rate grew by 50 basis points to 4.75%. This equals a monthly increase of $59.41 or a yearly gain of $712.92.

Basis points can also impact the overall cost of the mortgage. For example, if a borrower takes out a $200,000 30-year fixed-rate mortgage at 4.25% interest, the total mortgage cost over 30 years will be $354,197. The total mortgage expense over 30 years would rise to $377,164 if the interest rate rose by 50 basis points to 4.75%. This represents an increase of $22,967 over the life of the mortgage.

Pros of Basis Point in Mortgage

A basis point is a term used in the finance industry to express a small percentage change in the value or rate of a financial instrument. It is used in mortgages to describe changes in interest rates, bond yields, and other financial instruments. There are several pros to using basis points in mortgages −

• Precision − Basis points provide a more precise way to express changes in interest rates. Instead of expressing changes in interest rates in fractions of a percentage point, basis points offer a more accurate and standardized way of describing changes.

• Comparability − Using basis points, lenders can offer a more comparable interest rate across various products, helping borrowers compare loan options.

• Consistency − Basis points allow lenders to easily track and communicate changes in interest rates, enabling them to make informed decisions.

Avenues that use Basis Points

Basis points are used across various financial instruments, including mortgages, bonds, and other types of loans. They are particularly useful when small percentage changes can significantly impact the instrument's value or rate.

Formula and Computation of Basis Points

The formula for computing basis points is simple. One basis point equals 0.01% or one- hundredth of a percentage point. We need to multiply the percentage change by 100 to calculate the basis point.

For example, if a borrower is offered a 30-year fixed-rate mortgage at 4.5% and the lender raises the rate by 25 basis points, the new interest rate is 4.75%. To calculate this increase in basis points, simply multiply 0.25 by 100, which equals 25 basis points.

Examples of Basis Points

Let's consider an example of how basis points impact the cost of a mortgage.

A borrower takes out a 30-year fixed-rate mortgage for $200,000. The interest rate can be taken as 4.5%. The monthly payment on this mortgage would be $1,013.37, excluding taxes and insurance. Let us imagine that the mortgage interest rate rises by 50 basis points to 5.0%. The increased monthly mortgage payment would be $1,073.64, representing an increase of $60.27 per month or $723.24 per year. Over the life of the loan, this increase would amount to $21,697.20.

Conclusion

Basis points are a useful when it comes to mortgage computation. They provide a more precise and standardized way of expressing changes in interest rates, allowing lenders and borrowers to make informed decisions. By understanding basis points and how they are used in mortgages, borrowers can compare loan options and make informed decisions about their home financing.

FAQs

Q1. How are basis points calculated?

Ans. We need to multiply the percentage change by 100 to calculate the basis point. For example, if the interest rate on a mortgage rises by 25 basis points, the percentage increase is 0.25%.

Q2. How do basis points impact mortgage payments?

Ans. Small changes in interest rates can impact the cost of a mortgage. If there is a slight increase in the basis point, it will greatly impact the monthly payment.

Q3. How can borrowers use basis points to compare loan options?

Ans. By understanding basis points and how they impact mortgage payments, borrowers can compare loan options more accurately. They can also use basis points to understand how changes in interest rates could impact their monthly payments and the overall cost of their mortgage.