What is negative amortization?

Negative amortization occurs when the payments made on a loan are insufficient to cover the interest costs, leading to an increase in the overall loan balance. In this scenario, any unpaid interest is added to the principal balance, which means the borrower ends up owing more than they originally borrowed as the loan progresses. This situation is particularly common in certain types of loans, such as adjustable-rate mortgages, where payments can be lower initially.

Understanding this term is crucial for borrowers, as negative amortization can lead to financial difficulty over time if not managed properly, making option B the correct choice. The other options describe different aspects of loan repayment but do not accurately represent what negative amortization entails.