What is meant by "negative amortization" in a mortgage context?

Negative amortization occurs when the payments made on a loan are less than the interest being charged on that loan, leading to an increase in the total loan balance over time. This situation typically arises in certain types of loans, such as adjustable-rate mortgages or loans with payment options where the borrower chooses to pay only a portion of the interest or even less.

When the borrower makes payments that do not cover the full interest amount, the unpaid interest is added to the principal balance. As a result, instead of decreasing, the loan balance grows, which can be problematic for borrowers since they might owe more than the original amount borrowed as time goes on. This practice can lead to challenges in managing the loan’s repayment, especially if property values decline or if the borrower’s financial situation changes.

Understanding negative amortization is crucial for borrowers to make informed decisions about their mortgage options and to avoid unexpected increases in their debt.