Basis points (also known as bps and bips) are a unit of measurement to compare interest rates on financial products like small business loans, credit cards, stocks and bonds, or even equity securities. Knowing how basis points work helps to reduce confusion when talking about percentages and changes in percentages where one basis point equals 0.01%, which is one percent of 1%. Yes, this sounds confusing now, but it is about to get easier.
While this same concept and the calculations apply to most financial products, we’ll focus on financing examples here in this guide.
When negotiating a loan, you may see a 10% base rate. What you and the lender say next, as far as percentages and points go, makes a big difference in the amount you could end up paying. If the base rate is 10%, it should not increase by more than 10% of that base rate (i.e., 1 percentage point) per year.
- Base rate = 10%
- Rate increase = 10 percent of 10% = 1%
- New rate = 11%
But the lender might misunderstand and think you mean 10 percentage points, which would be 10% + 10% = 20%. By converting to basis points, you prevent any confusion by saying the rate should not increase by more than 100 basis points each year. This way, you both know it will be a maximum of 1% and not (potentially) 10%. Here’s how to change from the percentages to basis points.
How to convert basis points and percentages
The table below shows how to convert basis points into percentages and vice versa:
| Convert | How to | Example |
| Basis points → Percent | Divide basis point by 100 | 50 basis points / 100 = 0.50% |
| Percent → Basis points | Multiply by 100 | 3% * 100 = 300 basis points |
In the example above, where you tell the lender the rate shouldn’t increase by more than 100 basis points, they should immediately know that you mean 1%:
- 100 basis points divided by 100 = 1%
If your credit is not as stellar and you need a faster approval, you could say 300 basis points, which would then equal 3%. Interest rates are how lenders make their money, and if your finances are where they need to be in order for you to qualify, knowing basis points helps you further showcase your financial knowledge and can help strengthen your case.
When you hear on the news that the Federal Reserve cut rates by 25 basis points, you’ll know the Fed Funds rate just dropped by 0.25%. In this case, the rate on the loans you have that are tied to the Fed funds rate should also drop.
How lenders and financial companies use basis points
Lenders and most financial institutions will use basis points while discussing loan and product terms with you:
- For an adjustable-rate loan, they might tell you the interest rate will be prime + 300 bps, meaning it will be 3% above the prime rate.
- Lenders might quote the fees and other terms as basis points, like telling you the origination fee is 75 basis points instead of saying 0.75%.
Basis points also help you compare loans across lenders that have different interest rates above prime based on business credit score. The interest rates quoted may change based on your business credit score because it is one of the signals used to calculate how risky of a borrower you are. But business credit scores are not the only factor used, and each lender will have different internal risk guidelines.
One lender might offer prime + 250 basis points, while another may offer prime + 300 bps. If the prime rate is 7.5%, you can compare the loans as follows:
- Lender 1 = 7.5% + 250 bps = 7.5% + (250 / 100) = 7.5% + 2.5% = 10%
- Lender 2 = 7.5% + 300 bps = 7.5% + (300 / 100) = 7.5% + 3.0% = 10.5%
You can see that Lender 2’s base rate is 50 basis points higher, but that doesn’t mean their loan is more expensive, as you still need to account for the fees. If Lender 1 charges 75 basis points for origination but Lender 2 charges a flat $1,000, then loan amount can play a big role in determining which lender is the better option.
| Loan Amount | Lender 1 Origination Fee | Lender 2 Origination Fee |
| $50,000 | $375 | $1,000 |
| $150,000 | $1,125 | $1,000 |
| $250,000 | $1,875 | $1,000 |
| $500,000 | $3,750 | $1,000 |
But that’s just the origination fee. The annual percentage rate (APR) on a loan will be higher than the base interest rate because it takes other costs (like origination fees) into account, so you can more easily compare loans with different base rates and different fees.
For a 5-year, $500,000 loan, Lender 1’s APR is equal to 10.326% and Lender 2’s APR is equal to 10.587%. While Lender 2 is still more expensive by 26.1 basis points, they might be worth it if they offer other benefits like not having a prepayment penalty.
Basis points also factor into terms and restrictions on loans, like if Lender 1 says that if your revenue or profit falls below specific thresholds, your rate will increase by 100 basis points as you’re now a higher-risk borrower. If this happens, then Lender 1’s base rate jumps to prime + 350 bps (11%), making Lender 1 more expensive than Lender 2 (10.5%) and costing you more of your cash flow due to the higher interest expense.
Using basis points when comparing loans and other financial products helps prevent confusion with percentages and how they’ll change. Now you know what to expect when the loan specialists talk about rates and basis points as you begin negotiating the terms of your small business loan.
