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Two words—basis points—are the key to measuring increases and decreases in interest rates. Changes in interest rates affect the mortgage you take out to purchase a home, the loan you get to buy a car and the amount of interest a bank or credit union pays on a savings account.
Basis points don’t only apply to interest rates. They also are frequently used in the context of credit card rates, Treasury bonds and many other corners of the world of finance. Beyond markets, they’re very often used to describe percentage amounts even for non-financial purposes.
What Is a Basis Point?
In order for traders and lenders to be more precise about interest rates, they often talk in terms of basis points rather than percentages.
One basis point is equal to 1/100th of one percent, or 0.01%. Taking those numbers into account, 10 basis points—abbreviated as bps—amount to 0.10%, 25 basis points add up to 0.25%, 50 basis points are equal to 0.50%, 75 basis points mean 0.75% and 100 basis points make 1.00%.
| Percentage | Basis Points (bps) |
|---|---|
0.10% | 10 |
0.25% | 25 |
0.50% | 50 |
0.75% | 75 |
1.00% | 100 |
If a lender informs you that the interest rate on a 30-year adjustable-rate mortgage (ARM) went up by 50 basis points, the rate might go from 5.50% to 6.00%.
If you wind up getting this mortgage, your monthly payments likely would be higher with a 6.00% mortgage than a 5.50% mortgage if all the other lending terms are the same.
The Federal Reserve and Basis Points
You often see or hear basis points mentioned when the Federal Open Market Committee (FOMC), a branch of the Federal Reserve System, raises or lowers the federal funds rate.
This is the Fed’s benchmark interest rate, used to determine how much one bank pays another bank for overnight loans.
In 2022, the FOMC approved seven hikes in the federal funds rate, with each being 25, 50 or 75 basis points. The chart below shows those increases.
Increases in Federal Funds Rate in 2022
| Date | Increase in basis points | Range for new federal funds rate |
|---|---|---|
March 17 | 25 | 0.25% to 0.50% |
May 5 | 50 | 0.75% to 1.00% |
June 16 | 75 | 1.50% to 1.75% |
July 28 | 75 | 2.25% to 2.50% |
Sept. 22 | 75 | 3.00% to 3.25% |
Nov. 3 | 75 | 3.75% to 4.00% |
Dec. 15 | 50 | 4.25% to 5.00% |
Source: Federal Reserve System
In a nutshell, the federal funds rate influences the interest rates you pay to borrow money, as well as the interest rates you earn on savings.
Prime Rate vs. SOFR
When the FOMC raises or lowers the federal funds rate, it impacts interest rates such as the prime rate and the Secured Overnight Financing Rate, or SOFR. Financial institutions use the prime rate as the interest rate they charge their best customers, and they use SOFR to set interest rates for some business and consumer loans.
The prime rate plays a big role in setting interest rates for lending products like credit cards, personal loans, variable-rate student loans, variable-rate mortgages and home equity loans. When the prime rate climbs, the cost of borrowing money typically climbs as well. And when the prime rate slides, the cost of borrowing usually slides too.
For example, if the federal funds rate goes up by 50 basis points and the prime rate follows suit, the annual percentage rate (APR) on a credit card might jump by 50 basis points—from 20.99% to 21.49%, for example.
Interest rates for other lending products, including fixed-rate mortgages and some student loans, tend to go up or down depending on the movement of SOFR. As with the prime rate, SOFR can make a difference in how much you pay in interest for certain lending products.
When Are Basis Points Used?
Lending isn’t the only financial area where basis points come into play.
You’ll also see or hear basis points cited when people are talking about things like savings accounts, interest-bearing checking accounts, certificates of deposit (CDs) and money market accounts. Basis points are often used to describe a change in value with regard to these instruments. But whereas a rise in basis points is bad for borrowers, it’s good for savers.
Typically, the movement of interest rates for savings accounts and other accounts that pay interest—rates expressed as annual percentage yield, or APY—aligns with the movement of the federal funds rate. So, if the FOMC hikes the federal funds rate, the APY for a high-yield savings account might rise 75 basis points, from 4.25% to 5.00%.
It’s important to remember, however, that basis points are not usually used when referring to stocks. Since interest rates don’t affect the stock market directly, changes in stock prices are referred to in dollars and cents.
How the FDIC Uses Basis Points
The Federal Deposit Insurance Corp. caps the interest rate that riskier financial institutions can pay on savings accounts, CDs, money market accounts and interest-bearing checking accounts.
Although financial institutions that the FDIC says don’t fall into the “less than well capitalized” category aren’t directly affected by the upper limit, the cap does set the tone for interest rates paid by all banks and credit unions.
To come up with the cap, the FDIC relies on several formulas, such as adding 75 basis points to the federal funds rate to compute the upper limit for non-maturity deposits (savings accounts, interest-bearing checking accounts and money market accounts).
