When you’re in the process of getting a mortgage or trying to understand the financial terms associated with it, you may come across the term “basis points.” Understanding what basis points mean can help you make more informed decisions about your mortgage and financial situation. In this article, we’ll explain what basis points are, how they are used in the mortgage industry, and why they matter.
What are Basis Points?
A basis point is a unit of measure used in finance to represent a small percentage change in a financial instrument, such as a mortgage interest rate or bond yield. One basis point is equal to one hundredth of a percent or 0.01%. For example, a change from 4.25% to 4.30% is an increase of 5 basis points.
In the mortgage industry, basis points are used to measure the difference between mortgage rates, the cost of a mortgage, and the yield on mortgage-backed securities. A basis point can be used to describe the difference between the interest rate of two mortgages, or the difference between the rate on a mortgage and the benchmark interest rate.
How are Basis Points Used in Mortgages?
When you’re applying for a mortgage, you’ll likely see interest rates listed in basis point. Mortgage rates can vary based on a number of factors, such as the size of the down payment, the borrower’s credit score, and the term of the loan. The interest rate on a mortgage determines the monthly payment and the total cost of the loan over its lifetime.
For example, a $300,000 mortgage with a 30-year term and a 4.25% interest rate would have a monthly payment of $1,475.82 and a total cost of $531,296.80 over the life of the loan. If the interest rate increased by 25 basis points to 4.50%, the monthly payment would increase to $1,520.06, and the total cost of the loan would increase to $547,216.84.
Basis points are also used to measure the yield on mortgage-backed securities (MBS). MBS are financial instruments that are backed by pools of mortgages, and they are bought and sold in the secondary market. Investors who buy MBS receive a stream of income from the interest and principal payments on the underlying mortgages. The yield on an MBS is the rate of return that investors receive on their investment.
Why Do Basis Points Matter?
They matter because they can have a significant impact on the cost of a mortgage or the yield on a mortgage-backed security. Small changes in interest rates can lead to significant differences in the monthly payment and total cost of a mortgage, as we saw in the example above.
They also matter because they are a common unit of measure in the financial industry, and they allow for easy comparison of different financial instruments. For example, if you’re trying to compare the yield on a 10-year Treasury bond and a 30-year mortgage-backed security, you can use basis points to make an apples-to-apples comparison.
They are a common unit of measure used in the mortgage industry to represent small percentage changes in interest rates, costs, and yields. Understanding what basis points are and how they are used can help you make more informed decisions about your mortgage and financial situation. When you’re shopping for a mortgage or comparing different financial instruments, be sure to pay attention to the number of basis points, as they can have a significant impact on your costs and returns. Call Abo Capital today with all your basis point questions at 310.984.8028, we’ve helped thousands navigate the lending process for over 35 years. Give us a call today!
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