Question 23

Negative amortization is an increase in mortgage debt when the payment is too small to cover the interest due.

Negative amortization occurs when the borrower’s payments do not cover the interest accrued on the loan, resulting in the principal balance increasing over time instead of decreasing.

A) The number of basis points a lender adds to an index.

This option is incorrect as it describes a component of interest rate calculations rather than the concept of negative amortization. Negative amortization specifically refers to the situation where payments fall short of covering the interest on a loan.

B) The result of an interest-only mortgage loan.

While interest-only mortgage loans can lead to negative amortization if the borrower eventually begins making insufficient payments, this option does not directly define negative amortization itself. Negative amortization is a broader term that describes any situation where the debt increases due to inadequate payments.

C) Insurance coverage that compensates for damage to property.

This option is entirely unrelated to the concept of negative amortization. It pertains to property insurance rather than financial calculations regarding loan payments and their impacts on principal balances.

D) An increase in mortgage debt when the payment is too small to cover the interest due.

This option accurately defines negative amortization. It explains how, when monthly payments do not meet the interest obligations, the remaining unpaid interest is added to the principal, leading to an increase in total debt.

Conclusion

Negative amortization specifically involves an increase in the principal balance of a mortgage due to insufficient payments that do not cover interest costs. Options A, B, and C do not correctly capture this financial phenomenon, while option D perfectly encapsulates the definition and implications of negative amortization. Thus, option D is the definitive correct answer.