PSI New Jersey Real Estate State Practice Exam

What does negative amortization refer to?

1. Paying more than the monthly interest

2. An increase in principal balance due to unpaid interest

3. Decreasing loan balances over time

4. The process of refinancing a loan

The correct answer is: An increase in principal balance due to unpaid interest

Negative amortization refers to the situation where the principal balance of a loan increases over time despite making regular payments. This occurs when the borrower’s monthly payment is less than the interest that accrues on the loan. As a result, the unpaid interest gets added to the principal balance, leading to an overall increase in what the borrower owes. This scenario is commonly seen in certain types of adjustable-rate mortgages or loans with low initial payment options, where the borrower is enticed by lower payments that do not cover the full interest expense. Over time, if the borrower continues to pay only the minimum amount, they will find themselves owing more than they originally borrowed, which is the essence of negative amortization. Other options, while related to loan payments, do not accurately describe negative amortization. For instance, paying more than the monthly interest would actually lead to a reduction in the principal balance. Similarly, decreasing loan balances over time would indicate positive amortization, where payments exceed accrued interest. The process of refinancing a loan is unrelated to the concept of amortization, whether negative or positive.