What does the term "negative amortization" refer to?

The term "negative amortization" refers specifically to a situation where loan payments do not cover the interest due on the loan. In this scenario, the interest that is not paid gets added to the principal balance, causing the total amount owed to increase over time. This can occur with certain types of loans, such as some adjustable-rate mortgages or loans with payment options, where the borrower chooses a payment that is less than the interest accrued. This situation can lead to a larger remaining balance than the original loan amount, making it crucial for borrowers to understand the implications of such an arrangement.

The other choices describe different financial concepts that do not accurately define negative amortization. For instance, a reduction in loan balance due to higher payments is a characteristic of traditional amortization where the borrower pays more than the interest due, while loan forgiveness refers to a complete discharge of the loan obligation, and an increase in equity from timely payments occurs in a fully amortizing loan where equity increases as the loan balance is paid down. Thus, these options do not align with the specific definition of negative amortization.