A payment-option ARM allows the borrower to make interest-only payments. If the borrower consistently chooses this option when rates are rising, what is the most likely outcome?
Correct Answer
C) Negative amortization will occur
When a borrower makes interest-only payments on a payment-option ARM during rising rate periods, the payment may not cover the full interest due at the new higher rate. This results in negative amortization, where the unpaid interest is added to the principal balance, causing the loan balance to grow.
Why This Is the Correct Answer
When a borrower makes interest-only payments on a payment-option ARM during rising rate periods, the payment may not cover the full interest due at the new higher rate. This results in negative amortization, where the unpaid interest is added to the principal balance, causing the loan balance to grow.
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