Final answer:
An adjustable-rate mortgage (ARM) with a 5/1 initial fixed period usually offers the lowest initial interest rate compared to other mortgage types, as the lender transfers the risk of future interest rate changes to the borrower.
Step-by-step explanation:
Among the types of mortgages listed, an adjustable-rate mortgage (ARM) with a 5/1 initial fixed period will probably have the lowest initial interest rate. ARMs typically offer lower initial rates than fixed-rate mortgages, because the risk of future interest rate changes is transferred from the lender to the borrower. The '5/1' in the ARM indicates that the initial interest rate is fixed for the first five years and then adjusts every year thereafter based on market conditions. In contrast, both fixed-rate mortgages and balloon mortgages offer interest rates that do not change for the duration of their respective initial periods, and interest-only mortgages often have rates similar to standard fixed-rate mortgages.
About the impact of a 3% drop in inflation on an ARM, it would likely lead to a decrease in the interest rate during the adjustment period, thereby lowering the borrower's monthly payments. This is because ARMs are designed to reflect changes in market interest rates, which are influenced by factors such as inflation.