What is negative amortization?

Negative amortization occurs when the payments made on a loan are insufficient to cover the interest that accrues during a specific period. As a result, the unpaid interest is added to the principal balance of the loan, increasing the total amount owed over time. This typically occurs in loans with adjustable rates or certain types of mortgages where borrowers are allowed to make lower monthly payments than are necessary to pay down the loan's interest fully.

The other options describe different financial concepts. Reducing the principal through payments refers to the standard process of amortization but does not capture the unique characteristics of negative amortization. An increase in rental costs over time pertains to real estate market trends and does not relate to loan repayment structures. Lastly, a fixed interest rate describes the stability of interest payments over time, which contrasts with the fluctuating nature of loans that may result in negative amortization.