Final answer:
Mortgages can only compound interest semi-annually or annually, not in advance. When mortgage interest rates are lower than the inflation rates, it benefits the borrower; conversely, higher mortgage rates compared to inflation benefit lenders. With adjustable-rate mortgages, if inflation falls, homeowners may pay less as market interest rates drop.
Step-by-step explanation:
According to the Federal Interest Act, mortgages can only compound interest semi-annually or annually, not in advance. This means that banks or lenders can apply compound interest to the principal of a mortgage twice a year or once a year, and this compounding cannot be applied beforehand. In the context of whether it's more advantageous for the borrower or the lender in a given year, simply comparing the mortgage interest rate with the rate of inflation can provide an insight. Generally, if the mortgage interest rates are lower than the inflation rates, it's more beneficial to the borrower because the real interest rate (taking into account inflation) is essentially reduced. Conversely, when mortgage interest rates are higher than inflation rates, lenders benefit more as they are earning more in real terms. For example, if the mortgage interest rate in a particular year is 5% and the inflation rate is 3%, the real interest rate is roughly 2%, favoring the lender. Conversely, if the inflation rate is 5% and the mortgage interest rate is 3%, the borrower has the advantage as the money they pay back in the future is worth less in real terms. When considering adjustable-rate mortgages, if inflation falls unexpectedly by 3%, the market interest rates are likely to drop, leading to a decrease in the periodic payments for a homeowner with an adjustable-rate mortgage. This is because the value of the money they are paying back is worth more, so in real terms, they end up paying less.