Negative amortization
Negative amortization is a loan balance that grows instead of shrinking. It happens when the payment made is less than the interest accruing, so the unpaid interest is added to the principal — and next month's interest is charged on the larger figure.
The technical term for that addition is deferred interest. The practical term is compounding in the wrong direction.
Where it comes from#
Three structures produce it.
Payment-option mortgages let the borrower choose among several payment amounts each month, one of which is smaller than the interest due. These were widespread before 2008 and are now rare in residential lending.
Graduated payment loans start with deliberately low payments that rise on a schedule. The early years can run negative by design.
Loan modifications frequently capitalise arrears — the missed payments, fees and advances are folded into the balance — or defer a slice of principal to be paid at maturity or on sale.
That third case is the live one. Most people who encounter negative amortization today encounter it in a modification they signed to keep their house.
Why it is not automatically bad#
A modification that capitalises arrears and lowers the payment can be exactly the right outcome for a household whose problem is monthly cash flow. The alternative was often losing the property.
What matters is knowing it happened. A borrower who believes they have been paying down a mortgage for four years, and finds at sale that the balance is higher than when the modification was signed, is in a very different position from one who planned for it.
The disclosure that matters#
Any structure permitting negative amortization has to say so, and the loan documents will contain a maximum — a cap on how far the balance can grow, typically expressed as a percentage of the original amount. When the balance reaches it, the loan recasts and the payment jumps to a fully amortising level.
That recast is the moment the deferral ends, and it arrives whether or not the household can absorb it.
How to check#
Compare the principal balance across two consecutive statements. If it is higher after a payment was made, interest is being added to it.
That check takes a minute and almost nobody runs it, which is why the discovery usually happens at a sale or a refinance — the two moments when it is too late to do anything except absorb the number.