Question

A party other than the borrower pays interest in advance to the lender, and the loan rate is reduced for the first couple of years in

a) Adjustable-rate mortgage
b) Fixed-rate mortgage
c) Interest-only mortgage
d) Reverse mortgage

Answer 1

a) Adjustable-rate mortgage

If inflation falls unexpectedly by 3%, a homeowner with an adjustable-rate mortgage would likely benefit from a reduced interest rate, leading to lower monthly payments, but they face the risk of rising payments if inflation increases.

Step-by-step explanation:

The question deals with an adjustable-rate mortgage (ARM), which is a loan for purchasing a home with an interest rate that varies alongside market interest rates, often influenced by inflation. If inflation falls unexpectedly by 3%, a homeowner with an ARM would likely experience a decrease in their interest rate. This is due to ARMs typically having built-in inflation adjustments, meaning that when inflation rates decrease, the interest rates on the loan adjust accordingly. Conversely, if inflation increases, the interest rates on ARMs would rise.

Therefore, in a scenario where inflation falls by 3%, the homeowner with an ARM could benefit from lower monthly payments. However, it's important to remember that this benefit comes with the risk that if inflation rises, the homeowner's payments could increase significantly.

Answer 2

The given scenario aligns with a buydown mortgage, which is not one of the listed options. An adjustable-rate mortgage (ARM) would see a decrease in interest rates with a fall in inflation, but this doesn't involve a third party paying interest in advance.

Step-by-step explanation:

The party subsidizing the interest initially to reduce the loan rate for the first few years is involved in a buydown mortgage, which is not one of the provided options. However, discussing the different mortgage types mentioned, none precisely fits this description. In fixed-rate mortgages, the interest rate remains constant throughout the term of the loan. An adjustable-rate mortgage (ARM) has an interest rate that changes with the market, and if unexpected inflation falls by 3%, the homeowner's interest rates would likely decrease, leading to lower periodic payments until the next rate adjustment.

An interest-only mortgage requires the borrower to pay only interest for the initial term, after which the loan reverts to a standard amortizing schedule. A reverse mortgage is typically used by older homeowners to convert part of their home equity into cash. Therefore, the scenario described doesn't accurately match any of the options