What does negative amortization indicate?

Negative amortization signifies a situation where the payments made on a loan are insufficient to cover the interest that accrues during that period. As a result, the unpaid interest is added to the principal balance of the loan, meaning the total amount owed increases rather than decreases over time. This can occur in certain types of loans, such as adjustable-rate mortgages, especially if the payment structure allows for lower initial payments that do not fully satisfy the interest obligation.

In contrast, other choices do not accurately capture the essence of negative amortization. A description of default would involve a borrower failing to meet their payment obligations, which is not directly related to the mechanics of negative amortization. Paying only the interest due each month refers to a specific payment strategy that does not result in negative amortization, as long as the payment covers the interest entirely. Deferring principal involves postponing the repayment of the principal amount but does not intrinsically mean that the interest is not being paid. Therefore, the best description of negative amortization focuses on the failure of payments to cover the interest due, resulting in an increasing loan balance.