California QM Practice Exam

The phenomenon of negative amortization occurs when a borrower’s monthly payments are insufficient to cover the interest on the loan, leading to an increase in the overall loan balance rather than a decrease. This typically happens in certain types of loans where the borrower has the option to pay less than the accrued interest.

As a result, the loan balance can grow to the point where it exceeds the value of the property securing the loan. This situation is significant for borrowers because it can lead to negative equity, meaning they owe more on the mortgage than the home is worth. This can complicate refinancing options or selling the property, as the borrower may face financial challenges.

In contrast, the other options do not accurately reflect risks associated with negative amortization. Increased equity, lower monthly payments, and immediate loan forgiveness do not align with the fundamental nature of negative amortization, which creates a liability for the borrower rather than alleviation of financial burdens.