Which payment option involves negative amortization on a pay option loan?

Which payment option involves negative amortization on a pay option loan?

• A. Minimum Payment (neg amortization)
• B. 30 year payment
• C. 15 year payment
• D. Interest only

Answer: (A)

Negative amortization happens when the payment made doesn’t fully cover the interest that accrues each month, so the unpaid interest is added to the loan balance. On a pay option loan, the minimum payment option is typically set below the monthly interest due. That shortfall is capitalized, causing the loan balance to grow over time—even though a payment is being made. The other payment choices are structured to reduce or maintain the balance in different ways: fully amortizing plans over 30 or 15 years are designed so each payment covers interest and reduces principal, and an interest-only option pays only the interest during its term, keeping the principal unchanged in that period.

Negative amortization happens when the payment made doesn’t fully cover the interest that accrues each month, so the unpaid interest is added to the loan balance. On a pay option loan, the minimum payment option is typically set below the monthly interest due. That shortfall is capitalized, causing the loan balance to grow over time—even though a payment is being made. The other payment choices are structured to reduce or maintain the balance in different ways: fully amortizing plans over 30 or 15 years are designed so each payment covers interest and reduces principal, and an interest-only option pays only the interest during its term, keeping the principal unchanged in that period.