What happens to the principal balance in a negative amortization scenario?

In a negative amortization scenario, the principal balance increases due to unpaid interest. This situation arises when the monthly payments made on the loan are less than the interest accrued during that period. When borrowers make a payment that is insufficient to cover the interest, the unpaid interest is added to the principal balance, leading to a higher amount owed over time.

This can happen with certain types of loans, such as adjustable-rate mortgages or some types of income-based repayment plans, where it may be permissible for borrowers to pay less than the total interest due. Consequently, this accumulation of unpaid interest results in a growing principal balance instead of decreasing it or keeping it constant.

The other options do not accurately describe the behavior of the principal balance in a negative amortization situation. For instance, the principal balance does not remain constant or steadily decrease; it definitely increases. Additionally, missed payments do not lead to forgiveness of the principal balance but rather contribute to the issue of negative amortization by adding to the total debt owed.