What are basis points?

People in the finance industry often talk about basis points when discussing topics like interest rate changes. Canstar explains what basis points are and why they can actually be pretty helpful to understand when you’re dealing with your own finances.

What is a basis point?

A basis point (bp, often pronounced as “bip”) is a unit of measurement. One basis point is equal to 0.01%, or 1/100th of 1%. Put another way, 100 basis points (bps) are equivalent to 1% or one percentage point.

Basis points are commonly used to describe differences or changes in interest rates and other percentages in finance. Another expression often used in these cases is “percentage points”. Both “basis points” and “percentage points” can be helpful terms for people talking about how much a percentage has changed by.

To give you an example, the Reserve Bank of Australia recently lowered the official cash rate from 0.25% to 0.10%. This means the cash rate decreased by 15 basis points, or 0.15 percentage points.

Basis points may also be used in an investment context as well, such as to show price changes in the stock market or the cost of ETFs and index funds.

Why do we use basis points?

You may be wondering why we use basis points instead of just percentages. The simple answer is that basis points can help to avoid confusion.

Say you had a home loan with a 3% interest rate and the rate increased by 1%. This could mean the interest rate is now 3% + 1% = 4% (an absolute value), or it could also mean the rate is 3% + 0.03% = 3.03% (a relative value). In other words, it is not clear whether the interest rate went up by 1% of the total loan amount, or 1% of the original 3% rate.

By instead saying the interest rate increased by 100 basis points (or one percentage point), this makes it clear that the 3% + 1% = 4% calculation is correct.

Basis points are also convenient to use when explaining smaller changes in percentages. For example, if you had a savings account with an interest rate of 1.10% and it dropped to 1%, it is often clearer to say it decreased by 10 basis points rather than 0.1%.

Examples of how basis points work

To convert basis points to percentage points, you simply divide the basis points by 100. On the flipside, to change percentage points to basis points, you multiply the percentage points by 100. Here are a couple of examples:

If you want to talk about how much a percentage has changed by in terms of basis points or percentage points, then here are a few examples, assuming a hypothetical product with a starting interest rate of 2%:

Cover image source: Southworks (Shutterstock).