Understanding Mortgage Basis Points in Commercial Real Estate
In every financial transaction, the details determine the rate of return or profitability of any deal. One component of that process is mortgage basis points. Base points are used in a wide range of financial components of any commercial mortgage transaction. This includes spreads and fees.
Understanding Mortgage Basis Points
Sometimes called BPS, mortgage basis points help to measure financial instruments. Most often, each point is worth 0.01 percent of 1 percent. This means that when the fees of a commercial mortgage are at 100 basis points, that indicates they are 1% of the total mortgage value.
Why Do Basis Points Matter?
In many commercial mortgage finance transactions, basis points provide insight into affordability and the overall cost of borrowing. It is not uncommon for lenders to provide insight that basis points have increased by a certain number. This then enables the investor to determine what amount – or percentage – the change represents to them.
It is possible for basis points to go down, too. For investors, this could signal an opportunity to see savings if they finance using a lower rate, for example.
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When the Federal Reserve Board issues a statement that they have raised the key lending rate by a certain number of basis points, such as 25 basis points, that means it has increased by a quarter of a percent or .25%. If the current target interest rate is 2.5%, and an increase of 25 basis points occurs, that means the new rate would be 2.75%.
Another factor is to consider how basis points may impact adjustable rate loans. In situations where a fixed rate is obtained, the interest rate on the loan will remain the same from the start of the loan through the final payment. That is not the case when it comes to adjustable-rate loans. In these situations, the rate can fluctuate over time.
Most often, an adjustable-rate mortgage, also known as an ARM, will typically have a set number of months where the rate remains the same. Then, after that intro period, the rate can adjust based on changes in key lending rates. This may include the opportunity to go down, but most commonly, it will go up. It can be adjusted as often as once every quarter in some situations.
That means that, for those who obtain an ARM, an increase in basis points throughout the loan term could make the loan more expensive over time. This could impact investment decisions for some borrowers.
How Mortgage Basis Points Are Calculated
The simplest way to calculate basis points is to move the decimal point by two spaces to the left. As noted, each basis point has a value of 0.01 of 1%. That means if a lender shares that the currently available loan offers have increased by 30 basis points, that means the rate has increased by .30%.
One basis point is 1/100th of 1 percent. That is also the same as 0.0001. To get a percentage to basis points, divide the percentage by 0.001.
Here is another calculation to consider. To convert the basis points figure into a percentage:
- Basis points x 0.001
- This provides the decimal.
- Convert that into a percentage by multiplying that figure by 100.
How Do Basis Points Affect Mortgage?
Basis points are a critical factor when considering a commercial mortgage. It helps to measure key factors that impact the cost of the financial instruments. That includes rates but also fees and spreads that relate to the industry and the finance of commercial real estate in general.
Consider how this may apply if there is an increase in the fees associated with obtaining a loan. The lender may not say the loan fees are increasing by $100. Rather, they will state the number of basis points the costs are rising by, and it is then possible to determine what that figure is.
For example, a lender may state that fees are increasing by 200 basis points. That means that fees are going up by 2% of the borrowed funds for the loan. That is going to have a significant impact on what the investor pays to borrow money to purchase the property.
It may also be a valuable tool when considering negotiations with a commercial loan lender. In some situations, an investor may be able to negotiate the conditions, such as determining how many basis points are in the spread. This could lead to a lower cost. The spread in the transaction is typically the amount of money the lender will earn in profit from this transaction. Negotiating a lower spread by offering a lower basis point figure could help to reduce the overall costs of borrowing those funds.
In some situations, lenders may focus on spread rather than on interest rates and terms of a loan. That is because interest rates can be skewed based on the various amortization, underwriting costs, and different rates. Even the length may differ from one offer to the next. Focusing on raising or lowering the spread by basis points provides a more even, simplified way to compare two offers or opportunities fairly.
Are Mortgage Basis Points the Same as Discount Points?
Mortgage basis points are not the same as discount points. This is a very common misunderstanding that can cause confusion during a mortgage transaction for commercial real estate.
Mortgage discount points are quite different. They are points you can borrow at the time of securing a mortgage. This is done before securing a loan with the goal of lowering the interest rate on that loan. The use of mortgage discount points is often related to lowering the cost of interest rates on loans. As a result, it can help to reduce the overall cost of loans but does require that the buyer put more money upfront on the transaction.
More so, mortgage discount points are not always equal to the same factor. Each lender can determine what one point is equal to for their specific needs. That makes it a bit harder to compare loans across numerous lenders.
In most cases, a mortgage discount point is equal to 1 percent of the loan amount. If the buyer purchases 1 point, then they will see the interest rate on their loan drop by 25 points or .25 percent. It is up to the buyer to determine if this is beneficial to them based on the way they plan to utilize and maintain the loan over time.
By comparison, basis points are applied to not just interest rates but spreads and fees. They can also be used to calculate mutual funds and bonds. They may also be used in bond ETFs as well.
Wrapping Things Up
As an investor, it is critical to understand the current interest rates, fees, and spreads of any transaction prior to entering into it. With mortgage basis points, it is possible to see the specific financial impact that any change could create. It is possible to calculate basis points and their impact on many commercial loans over time, providing a better understanding of the actual cost to borrow money and repay it for any commercial real estate.