Negative amortization occurs when

Rationale

Negative amortization occurs when payment is less than accrued interest.

Negative amortization happens when the monthly payment made on a loan is insufficient to cover the interest that accrues over that period, resulting in an increase in the loan balance rather than a decrease. This situation can lead borrowers to owe more than the original loan amount over time.

A (ARM margin is increased) YOUR ANSWER

An increase in the adjustable-rate mortgage (ARM) margin refers to the addition of a fixed percentage added to the index rate when determining the interest rate on an ARM loan. While this change can affect the overall payment amount, it does not directly lead to negative amortization unless the payment remains below the accrued interest.

B (payment is interest-only) YOUR ANSWER

An interest-only payment means that the borrower is paying only the interest on the loan for a specified period, not reducing the principal balance. While this can lead to a stagnant principal balance, it does not inherently cause negative amortization unless the payment is less than the actual accrued interest, which is not always the case.

C (payment is less than accrued interest) CORRECT

When the payment made is less than the interest that has accrued during the billing cycle, the unpaid interest is added to the principal balance of the loan. This results in negative amortization, as the borrower is effectively increasing their debt instead of paying it down.

D (index is adjusted) YOUR ANSWER

Adjusting the index refers to changes in the benchmark interest rate that affects the loan's interest rate. This adjustment can influence the payment amount but does not directly result in negative amortization unless the payment is not sufficient to cover the accrued interest.

Conclusion

Negative amortization occurs specifically when the payments made on a loan are insufficient to cover the accrued interest, leading to an increase in the overall loan balance. While other choices discuss factors related to loan payments, only option C accurately describes the condition under which negative amortization arises. Understanding this concept is crucial for borrowers to manage their loans effectively and avoid increasing debt.

Negative amortization occurs when

Negative amortization occurs when payment is less than accrued interest.

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