Negative Amortization

Normal amortization shrinks a loan: each payment covers the interest and puts the rest toward principal. Negative amortization is that process running backwards. The payment does not cover the interest accruing, the unpaid portion is capitalized into the balance, and you owe more after paying than you did before.

The most common place borrowers meet it today is income-driven student loan repayment, where the payment is calculated from income rather than from the balance. A low enough income produces a payment below the accruing interest, and the balance climbs for years of faithful, on-time payments.

Its notorious form was the option ARM of the mid-2000s, which let borrowers choose a minimum payment below the interest due. Balances grew silently until a scheduled recast forced a payment large enough to repay the swollen loan in the remaining term. Federal qualified-mortgage rules now bar negative amortization on most home loans.

On a property it is doubly dangerous, because a rising balance and a flat or falling market value can push equity below zero — leaving the owner underwater and unable to sell without bringing cash to closing.

The warning sign is simple and easy to check: a statement balance that rises or refuses to fall despite payments being made. The remedy is to pay at least the interest accruing each period, even when a smaller payment is permitted.