It occurs when a principal balance on a mortgage loan increases because the monthly loan payment is lower than the amount of monthly interest being charged.
What is it?
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A. B. C. D.A
The correct answer is A. Negative amortization.
Negative amortization occurs when the monthly loan payment made by a borrower is not sufficient to cover the monthly interest charged on the loan, causing the unpaid interest to be added to the principal balance of the loan. This results in the principal balance of the loan increasing over time rather than decreasing, which is the opposite of what happens with positive amortization.
The reason this happens is because some types of loans, such as adjustable-rate mortgages, have a feature called a payment cap. This means that the monthly payment cannot increase by more than a certain amount each year, even if the interest rate on the loan goes up. As a result, if the interest rate on the loan increases to the point where the monthly payment is not enough to cover the interest charges, the unpaid interest is added to the principal balance of the loan, causing negative amortization.
Negative amortization can be a risky situation for borrowers because it can result in them owing more on their loan than they originally borrowed. This can make it difficult to sell the property or refinance the loan in the future, and can also result in higher monthly payments if the loan is eventually reset to a fully amortizing payment schedule.
In contrast, positive amortization occurs when the monthly loan payment is sufficient to cover both the interest charges and a portion of the principal balance, causing the principal balance of the loan to decrease over time. Positive amortization is the desired outcome for most borrowers because it allows them to build equity in the property and pay off the loan in full over time.