You'll hear the term "basis points" often used in connection with mortgages. One basis point is 1/100 of 1 percent. While certainly not a large percentage amount, basis points can be extremely important in mortgage situations. Because of the size of mortgage loans, basis points – although small numbers – can affect interest rates and your costs to finance your home. When you hear or read about an increase/decrease of 25 basis points, you should know this means one-quarter of 1 percent.
Importance to Lenders
Particularly important to large-volume mortgage lenders, basis points -- even just a few -- can mean the difference between profit and loss. Financially speaking, mortgage basis points are more important to lenders than to borrowers. However, this impact on lenders can also affect your mortgage interest rate.
For example, mortgage lenders that must pay 10 extra basis points for loans when selling them may increase by 0.25 or 0.375 percent their offered mortgage rate to borrowers – possibly you.
Why Basis Points Are Used
Basis points are popular with larger investments such as bonds and mortgages because small increases or decreases in interest rates can represent large dollars. Unless you work in the world of finance, you may not be aware of the popularity of basis points. From a mortgage perspective, small increases in basis points can mean larger changes in the interest rate you might pay.
For example, if large mortgage buyers like the Federal National Mortgage Association increase their "buy rate" by 18 basis points, many lenders will raise their published interest by 25 basis points – one-quarter of 1 percent.
Consumer Uses for Basis Points
When you compare mortgage rates and terms, you will eventually encounter basis points. For example, you talk to a loan officer, telling him/her that you want to lock -- guarantee your rate at closing -- your rate for 60 days. The loan officer then advises you that the lender charges 50 basis points to lock your rate for that period. This means that it will cost you one-half of 1 percent of your mortgage loan balance to lock your rate for 60 days.
Follow the Mortgage Market
Mortgage rates tend to "lag" – be a bit behind – other market interest rates. Understanding basis points might help you, to a degree, predict where mortgage rates are going. If you are almost ready to make a mortgage application, knowledge of basis points may help you save some money.
For example, you notice bond yields and prices increased by 20 basis points on Monday. Mortgage-backed securities, traded in the same market, will also follow. This may indicate an increase in mortgage interest rates by one-eighth to one-quarter by Tuesday or Wednesday.
