What is negative amortization?

Negative amortization occurs when the monthly payments made on a loan are insufficient to cover the total interest that accrues. Because the payments do not fully cover the interest, the unpaid interest is added to the principal balance of the loan. This results in the total amount owed increasing over time, rather than decreasing, which can create significant financial strain for the borrower.

The crucial aspect of negative amortization is that it can lead to a larger debt load than what was initially borrowed, which is especially problematic for borrowers who may already be struggling to meet their financial obligations. This situation typically arises in certain types of adjustable-rate loans or loans with payment options that allow for smaller payments than the full interest amount. Understanding this concept is vital for anyone working in the mortgage industry, as it impacts loan structure and borrower financial health.