Interest Rates Are Above 6%. This Is How Much More You'll Pay in Interest for a $500k Home

Home buyers are in for some bad news relating to interest rates.

It appears new home buyers will face additional headwinds in the coming months, as rates topped 6% in September. Mortgage rates are at their highest level since November 2008. For home buyers who waited until now to borrow, the price difference could be hundreds of thousands of dollars in interest.

Inflation, the economy, and monetary policy

It only took 12 months for mortgage rates to double, leaving many to wonder how we got here. When it comes to mortgage lending, a variety of factors can affect rates, including inflation, economic growth, and monetary policy.

Inflation has been a headliner for most of 2022, and is hitting Americans across their budgets. However, while inflation typically follows periods of high economic growth, today's economic environment appears to be a stagflationary one. In stagflation, inflation is high even while the overall economy is slipping. When inflation is high, mortgage lenders try to protect the purchasing power of their future dollars by raising rates. However, when economic indicators are poor, mortgage lenders prepare for lean months ahead by further boosting today's rates.

Additionally, the Federal Reserve is attempting to cool inflation by leveraging some of the tools in its toolbox. Included in these tools is something known as the federal funds rate, the rate at which banks borrow from each other on a short-term basis. By raising this rate, the Fed is making it more expensive for banks to borrow, in theory slowing down lending demand and inflation. When it costs more for your bank to borrow money, you can bet the price will be passed down the line to you.

Putting it into practice

Now that we understand why rates have risen in the past nine months, let's illustrate with an example using Motley Fool Money's mortgage calculator. Let's assume you are purchasing a home and taking out a mortgage of $500,000 to finance your purchase. What would happen if you bought now versus at the beginning of the year?

Currently, the average 30-year mortgage rate is 6.02%. At that rate, a mortgage of $500,000 would accrue $581,971 in interest over the 30-year life of the loan. However, had you taken the same loan out at the beginning of the year, your interest rate would have been only 3.22%. Over the life of the mortgage, only $280,017 of interest would accrue. By waiting nine months to take out a loan, you'll end up paying over $300,000 more for the same mortgage!

A perfect storm of inflation, economic stagnation, and federal funds rate appreciation have made it a tough time to take out a mortgage. While the future of lending is uncertain, the past is clear: Borrowing at the beginning of the year was the right choice for prospective homeowners.