Search
Close this search box.

November 4, 2022

Cost of Credit and How It Affects Interest Rates

The bottom line is it costs money to make money and I’m going to explore what drives lending costs in this episode. Here is a simple way to understand this: the interest rate of a loan is the profit margin that a bank or lender makes. Without getting too deep into the matrix, I’m going to discuss Par, Basis Points (BPS), and how BPS (also known as “bips”) affect your monthly mortgage.

Par

Par is basically the level point. It is the zero line when it comes to a lender. If a bank or lender loans money out at par, then that bank will neither make money nor lose money on that loan. Par equals 100 and it resets everyday. So if a bank lends out money, it must charge a certain interest rate above par in order to make lending money worthwhile.

Basis Points – BPS or “Bips”

100 bps is virtually the same as 1% which is the same as 1.00. The bps recognize whether the cost of credit has increased, decreases, or remained the same from the day before. If the bps didn’t change from the day before, then par remains the same and home interest rates won’t move.

Let’s say the basis points drop 200bps (-2.00) in the morning. That means if a bank loans out money at a par interest rate, they will lose two percent on that investment since the basis points are no longer at 100 (Par) and are now at 98. Let’s say the basis points rise 200bps (+2.00) in the morning. That means if a bank loans out money at a par interest rate, they will gain two percent on that investment since the basis points are no longer at 100 (Par) and are now at 102. In a sense, you can almost relate basis points as ‘profit points’. I can’t get into what drives basis points in this episode, because then we’d be entering the Matrix, but for simplicity’s sake, bps are the driving force behind rising and falling interest rates for home mortgage loans.

Screenshot_20221104-071342_2
Drop in Basis Points From Spring 2022 to Fall 2022

 

BPS Interest Rate Scenario

Let’s take a $100,000 loan and a 10% Par interest rate as an example. Let’s say that a bank must charge 2% above par to make a return on their investment, they would have to charge 12%. Now if the bps dropped 200bps by the end of the day and Par reset at 12% the following day (Tuesday), then that same loan term would have to increase to 14% to get their return. Let’s say on Wednesday, Par started at the same rate as Tuesday ended, but it jumped up to 102.00 by the end of day, then the cost of lending will close 200bps higher, which is the same as par opened on Monday. Beginning Thursday morning, the bank could charge 12% as it did opening on Monday. Furthermore, if the basis points climbed another 200bps by end of day, Friday morning the bank could lower its interest rate down to 10%, and so on and so forth.

Local Mortgage Broker Advantage in Colorado

Mortgage brokers are in and out of loan pricing scenarios every day, they are a great resource to stay in touch with as they have access to daily bp changes and see where the market is trending toward BEFORE it makes it to public media. This is in part how future casters can predict with some form of accuracy where the market may land in a year or two. Future casters don’t have a crystal ball, but they do have insight as to what tends to follow certain historical patterns. Whatever your situation there’s a Juicy Solution waiting for you. Take a look around the website or get in touch with me and I will connect you with my team or one of the many real estate professionals I work with both here in and beyond Colorado Springs, Colorado.

_DSC6419

Funding Juicy Solutions LLC

T: 619-402-9221
email: info@fjsolutionsllc.com

NMLS# 2269838