What describes negative amortization?

Negative amortization occurs when the monthly payments made on a loan are not sufficient to cover the interest due for that period. As a result, the unpaid interest is added to the principal balance of the loan, leading to an increase in the total amount owed over time. This situation can arise in loan structures where the monthly payment is set intentionally lower than what would be required to fully pay off the interest, as seen in some adjustable-rate mortgages or certain types of loans designed to attract borrowers with low initial payments.

By understanding that negative amortization increases your principal balance, borrowers can recognize the long-term implications of such loans, including the risk of owing more than the original amount borrowed, which can complicate future refinancing or sale options.