Question

Adjustable-rate mortgages are riskier than fixed-rate mortgages. However, they may be useful when the interest rate is expected to ________ in the future.

A) increase
B) decrease
C) remain stable
D) None of the above.

Answer 1

Adjustable-rate mortgages are preferred over fixed-rate mortgages when interest rates are expected to decrease. A drop in inflation typically leads to lower market interest rates, which would likely reduce the interest rate on an ARM, resulting in lower monthly payments.

Step-by-step explanation:

Adjustable-rate mortgages (ARMs) are often chosen over fixed-rate mortgages when the interest rate is expected to decrease in the future. If market interest rates go down, so could the interest rate on the ARM, leading to potentially lower monthly payments for the borrower. However, there is risk involved because if market interest rates go up, so will the interest rate on the ARM, leading to higher monthly payments.

When inflation falls unexpectedly, as mentioned in the question, it often leads to a decrease in market interest rates. If a homeowner has an adjustable-rate mortgage, and inflation falls by 3%, it's likely that the interest rate on their mortgage will also decrease. This could result in lower monthly mortgage payments for the homeowner, which is an advantage of having an ARM in a declining interest rate environment.