What is negative amortization in real estate?

In real estate, negative amortization occurs when the payments made on a loan are insufficient to cover the interest that accrues over a specific period. When this happens, the unpaid interest is added to the principal balance of the loan, leading to an increase in the total amount owed. This can result in the borrower owing more than the original loan amount over time, which is a significant financial risk.

This scenario typically arises in loans with low initial payments, such as some adjustable-rate mortgages, where the interest rates can fluctuate. The borrower may initially benefit from lower monthly payments, but if those payments do not keep up with the interest, it creates a situation where the debt grows instead of decreases.

Other choices refer to concepts that do not directly define negative amortization. For instance, increasing property value relates to appreciation or improvements made, refinancing is a strategy to obtain better loan terms, and adjustable-rate mortgages can have various features but are not solely defined by negative amortization. Therefore, the most accurate description of negative amortization is that it occurs when loan payments are less than the interest due.