Final answer:
The most common type of mortgage where payments include both principal and interest is the fixed-rate mortgage. Homeowners with an adjustable-rate mortgage might benefit from a fall in inflation as it can reduce their interest rates and monthly payments. The real interest rate determines the advantage between borrower and lender in various economic conditions.
Step-by-step explanation:
The most common type of payment arrangement for residential mortgages, where each payment is a blend of principal and interest based on the mortgage's amortization schedule, is a fixed-rate mortgage. This type of mortgage maintains the same interest rate over the entire life of the loan, regardless of changes in the market interest rates. With a fixed-rate mortgage, if inflation falls unexpectedly by 3%, the homeowner with an adjustable-rate mortgage (ARM) would likely benefit, as the interest rates on ARMs can decrease in response to falling inflation, potentially reducing the monthly payments for the homeowner.
When considering whether it's better to be a borrower or a lender in various years based on the mortgage interest rate and rate of inflation, one should look at the real interest rate, which is the mortgage rate minus inflation. As a general rule, if the real interest rate is low, it's better to be a borrower, and if it's high, it's better to be a lender. With adjustable-rate mortgages, lenders are protected against inflation reducing real loan payments, thereby allowing them to offer lower initial interest rates compared to fixed-rate mortgages.