What is the amortization method called when monthly payments do not cover all interest, resulting in a balance increase?

The amortization method where monthly payments do not fully cover the interest charges, leading to an increase in the loan balance, is known as negative amortization. In this scenario, the borrower’s payments are insufficient to pay off the accrued interest, causing the unpaid interest to be added to the principal balance of the loan.

This situation commonly arises in certain types of loans, such as some adjustable-rate mortgages or deferred interest loans, where the homeowner may have a temporary reduction in monthly payments, resulting in the loan balance growing over time instead of decreasing. Negative amortization can lead to significant financial strain when the loan must eventually be repaid, as the balance can become larger than the original amount borrowed.

Understanding negative amortization is critical for mortgage loan officers as it can impact a borrower’s financial situation, and they need to ensure that potential clients are aware of the risks associated with such loans.