Basis Points

You may have heard the term basis points in passing but were never quite sure exactly what it means. 
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Basis Points Explained

You may have heard the term basis points in passing but were never quite sure exactly what it means.

To be equipped to discuss interest rates, you need to have a solid understanding of how basis points work.

What are Basis Points?

Basis points are a unit of measurement commonly used when discussing interest rates or other percentages in the financial world.

Often they can be called bps or bips for short. The name stems from the ‘base’ move between two percentages.

You may come across this term in these areas and others:

  • Shares in the stock market
  • ETFs and mutual funds
  • Student loan debt
  • Treasury notes
  • Mortgages
  • Bank account interest
  • Bond yields

What is the Value of a Basis Point?

One basis point equals 1/100 of 1 percent. In percentage form, one bp would be .01%. In decimal form, it would be .0001.

As another example, 10 basis points equals .1%.

As a quick reference, if you are converting from basis points to percentages, multiply by 100. If you are converting from percentages to basis points, divide by 100.

For those of us not great at math, it is a matter of moving the decimal point two places in either direction.

Why are They Needed?

Sometimes it might feel like the financial industry speaks another language intentionally to confuse outsiders. However, like so many other terms in the financial world, this one helps people to communicate more clearly when discussing rate changes.

Basis points are used to avoid any confusion when discussing changes in percentages.

For instance, if someone said a 10% rate changed by 10%, that could be understood to mean it is now 20% or it is now 11%. If instead, you say the 10% rate increased by 100 basis points, there is no confusion that the rate is now 11%.

Using basis points also provides a quick abbreviation for long-worded numbers. Instead of saying five-hundredths of a percent you can say 5 basis points.

You may see headlines that read ‘Federal Reserve Raises Interest Rates by 25bps’ and now you will know what they mean!

Points Add Up

Even a small change in rate can translate to thousands of dollars depending on the application.

50 basis points, or .5%, may not seem like a huge difference, but on a mortgage rate, it could mean the difference of tens of thousands of dollars.

The Bottom Line

Basis points are a term to simplify communication surrounding interest rates in the world of finance. Understanding basis points will make you a savvy borrower and investor.

Be sure to always review rates carefully and their potential to change depending on conditions in the financial world.

As always, if you have any questions relating to basis points, our experts are able to help!

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