Final answer:
A fixed-rate mortgage maintains a constant monthly payment and interest rate, whereas an adjustable-rate mortgage's interest rate can change with inflation. If inflation falls by 3%, an ARM's interest rate is likely to decrease, potentially lowering the homeowner's payments.
Step-by-step explanation:
Understanding Fixed-rate and Adjustable-rate Mortgages
On a fixed-rate mortgage, the monthly payment remains constant and the interest rate stays the same throughout the entire term of the loan. This provides the borrower with stability and predictability for budgeting purposes. In contrast, an adjustable-rate mortgage (ARM) has an interest rate that can fluctuate with market trends and often with the rate of inflation. Therefore, if inflation falls unexpectedly by 3%, it is likely that the interest rate on an ARM will decrease accordingly to realign with the new level of inflation, thus potentially lowering the future payments for a homeowner with this type of mortgage.
ARMs often include built-in inflation adjustments to protect lenders against the risk that higher inflation will diminish the real value of ongoing loan payments. Even though ARMs may start with a lower interest rate compared to fixed-rate mortgages, borrowers are exposed to the risk of fluctuating payments if the inflation or market interest rates change after they have taken out the loan.