Basis points have a big impact on your finances, but not everyone knows what they mean or how they work.
Basis points are key to understanding your interest rates on loans and credit cards, as well as how much you earn on your savings. Here’s what you should know.
What are basis points?
Basis points, also known as “BPS” or “bips,” are a standard unit of measurement used to describe changes in interest rates. One basis point is equal to 1/100th of a percentage point. So if your mortgage with a 6% APR increases by 100 basis points, your rate on the loan will go up to 7%.
The term “basis points” is useful because it makes it easier to clearly communicate changes in an interest rate. For example, if you have an interest rate of 3% and it increases by 1%, you might naturally (but incorrectly) assume it went up to 4%. However, a 1% increase results in a rate of 3.03%. To avoid confusion, you can say the rate increased by three basis points.
Understanding basis points
Basis points come into play with many financial concepts. One that likely applies to your life is when the Federal Reserve increases or decreases the federal funds rate.
These changes can be expressed in basis points. And if you have a bank account, credit card, or variable-rate loan, they impact you directly. Here are the main ways you can affected by changes in basis points.
New debt
Basis points play a role in the interest rates on new mortgages, auto loans, credit cards, and other debt. If the Fed hikes its target rate by a certain number of basis points, your interest rate on new debt is likely to go up. In other words, it will be more expensive to borrow money.
Debt with variable interest rates
If your debt has a fixed interest rate, it won’t change for the duration of the loan. However, if you have accounts with variable interest rates, you can expect them to change from time to time (along with your monthly payment) — potentially by several basis points.
These types of debt commonly have variable rates:
Read more: Fixed rate vs. variable rate: What’s the difference, and why does it matter?
Bank deposits
One of the ways you can benefit when basis points increase is at the bank. When the Fed increases its target rate, interest rates paid on bank deposits (represented as APY) can increase too. Banks aren’t required to raise rates in tandem with the Fed, but you can generally expect rates to increase on the following account types:
How to calculate basis points
Converting basis points to percentages, or vice versa, sounds complicated but is not that hard to do. You can use these formulas or the cheat sheet below:
Frequently asked questions (FAQs)
How much is 50 basis points?
If you use the formula for converting BPS to percentages (dividing basis points by 100), you see that 50 BPS equals 0.50%. For example, if you start with a rate of 5.00%, a 50 BPS increase results in a rate of 5.50%.
How much is 100 basis points?
One hundred basis points is the equivalent of a one percentage point change. If your rate starts at 5% and decreases by 100 basis points, the result is a rate of 4%.
Why do they use basis points instead of percentage?
Using basis points makes it easier to accurately express changes in an interest rate. For example, the difference between 10% and 11% might appear to be a 1% increase, but it’s actually a 10% increase or an increase of one percentage point. To avoid confusion, you can say the rate increased by 100 basis points.