California Real Estate SalespersonFinancingMedium
An adjustable-rate loan includes a monthly payment cap limiting how much the payment can increase regardless of interest rate changes. During a period of rising rates, the capped payment is insufficient to cover all interest due, and the shortfall is added to the loan's principal balance. This outcome is called:
- ANegative amortization
- BLoan acceleration
- CImpound shortage
- DRate lock
Show answer & explanationAnswer & explanation
Correct answer: A. Negative amortization
Negative amortization occurs when the scheduled payment is less than the interest accruing on the loan, causing the unpaid interest to be added to the principal balance, so the loan balance grows instead of shrinking over time.
Why the other options are wrong
- B. Acceleration means demanding full repayment early, unrelated to a growing balance.
- C. An impound shortage relates to escrow account funds for taxes/insurance, not loan principal growth.
- D. A rate lock fixes an interest rate for a period before closing; it does not describe a payment cap effect.
Negative Amortization
A loan condition where payments are insufficient to cover accruing interest, causing unpaid interest to be added to the principal, increasing the loan balance over time.
- Common in payment-capped ARMs and some graduated payment loans
- Loan balance can exceed the original amount borrowed
- Increases risk that the loan balance surpasses property value
Memory trick: Pay too little, owe even more — the balance balloons backward.