Difficulty: Hard

Average Score: 40%

Negative amortization is

Rationale

Negative amortization is an increase in mortgage debt that occurs when the monthly payment is not large enough to cover the interest due.

Negative amortization happens when the payments made on a loan do not cover the full interest owed, leading to an increase in the principal balance over time. This situation can be particularly concerning for borrowers, as it can result in owing more than the original loan amount.

A (the number of basis points a lender adds to an index to determine the interest rate of an adjustable-rate mortgage.) YOUR ANSWER

This choice describes the method of calculating interest rates for adjustable-rate mortgages but does not address negative amortization. It refers to how lenders set rates based on an index, which is unrelated to the issue of increasing debt due to insufficient payments.

B (the result of every interest-only mortgage loan.) YOUR ANSWER

While interest-only mortgages can lead to negative amortization if payments do not later address the principal, not all interest-only loans result in this situation. Borrowers may later choose to pay down the principal, avoiding negative amortization altogether.

C (insurance coverage on real estate that compensates the owner for physical damage to a property from fire, wind, or other hazards.) YOUR ANSWER

This choice defines property insurance, which protects against physical damage to real estate. It does not pertain to the concept of negative amortization, which is strictly related to loan payment structures and debt increases.

Conclusion

Negative amortization specifically refers to the scenario where the monthly mortgage payments fail to cover the interest due, resulting in a growing debt burden for the borrower. Understanding this concept is crucial for borrowers to avoid financial pitfalls associated with insufficient payment plans, differentiating it clearly from unrelated mortgage terms and conditions.

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