What does negative amortization indicate regarding a loan?

Negative amortization refers to a situation in which the payments made on a loan are insufficient to cover the interest charges that accrue over a period. As a result, instead of the loan balance decreasing, it actually increases because the unpaid interest is added to the principal amount. This can lead to a growing debt over time, as borrowers may owe more than they originally borrowed.

In this context, understanding the mechanics of negative amortization is crucial, especially for borrowers considering adjustable-rate mortgages or loans with features that allow for lower initial payments that may not cover the interest. In contrast, options that suggest the loan balance stays the same or that the loan is fully paid off do not accurately depict the reality of negative amortization, as neither of these conditions occurs when payments do not meet the interest charges.