A borrower with a $300,000 30-year fixed-rate mortgage at 6% interest discovers their payment was miscalculated and they've been paying $50 less than required for the first 12 months. What happens to their loan balance?
Correct Answer
B) The loan balance increases by more than $600 due to compounding interest
When payments are insufficient, the unpaid interest is typically added to the principal balance (negative amortization). Each month's shortage of $50 includes both unpaid principal and interest portions. The unpaid amounts compound because interest accrues on the higher remaining balance, creating a snowball effect that results in the total increase being more than the simple sum of the monthly shortages.
Why This Is the Correct Answer
When payments are insufficient, the unpaid interest is typically added to the principal balance (negative amortization). Each month's shortage of $50 includes both unpaid principal and interest portions. The unpaid amounts compound because interest accrues on the higher remaining balance, creating a snowball effect that results in the total increase being more than the simple sum of the monthly shortages.
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