Real estate

Ultimate Guide About Negative Amortization Loan 2023

Written By Urban Real Estate Center
Last Updated: Dec 15, 2022 •

If you want to purchase a new property in the next few years, you may consider getting a negative amortization loan. This type of loan can be very beneficial for those who can qualify for it. This guide will cover negative amortization loans, how they work, and who is eligible for them.

We will also discuss the pros and cons of getting a negative amortization loan so that you can make an informed decision about whether or not this type of loan is right for you.


What Is a Negatively Amortizing Loan?

A negatively amortizing loan is a type of mortgage in which the monthly payments are insufficient to cover the interest and principal balance. Every month, the difference between what is paid and what is due is added to the principal balance.

As this amount grows, so does the interest incurred on what you owe. In other words, even though borrowers make regular payments, they are falling further and further behind because they can't keep up with what they owe to the lender.

Although this may seem like a sensible option for some people at first glance, it's important to remember that a negatively amortizing loan should only be taken out as a last resort if you're comfortable increasing your debt over time instead of reducing it.


Short History of The Negatively Amortizing Loans

Negatively amortizing loans is a relatively new financing method that became popular in the late 2000s. A negatively amortizing loan is one where a borrower makes a series of payments that don’t cover the full amount of interest due on the amount of money borrowed.

It will instead consist of a minimum payment set lower than what would be necessary to pay off any accrued interest. This can put buyers in an even deeper financial hole over time, as the loan must be paid off eventually, and any interest built up needs to be addressed.

The global financial crisis of 2008 was an eye-opener for many as it exhibited how unreliable this type of loan can be when so many people had overextended themselves using ones that were overly generous with their amounts and lenient with their repayment plans.


How Does a Negatively Amortizing Loan Work?

Negatively amortizing loans can often be confusing and hard to understand. Prospective borrowers need to understand how negatively amortizing loans work to make informed decisions about taking out a loan.

With negatively amortizing loans, the interest rate is fixed and calculated on the remaining principal balance at each scheduled payment date. For example, if the loan has an interest rate of 8% annually and a remaining principal balance of $100,000, the interest due in that month would be 0.08/12 x 100000 = $666.67.

If the borrower makes a $500 payment, $166.67 worth of deferred interest ($666.67 - $500) will then be added to the total principal balance of the home loan, which would then become $100,166.67.

From thereon, with the consecutive payments, this same calculation applies, and this causes increases in the loan's total principal balance due year-on-year unless otherwise adjusted by other factors such as increased payments or change in the maturity period for that negatively amortizing home loan.


How many Types of negative amortization loans?

Negative amortization loans are a type of mortgage as payment for the loan is insufficient to cover the interest charges, allowing the unpaid interest portion to be added to the total balance of the loan. How many types exist?

In short, there are generally two types: periodic and cumulative negative amortization. Periodic negative amortization applies when a borrower makes payments that are less than what they would normally pay had they made regular payments.

This results in negative amortization, as each month's payment reduces the principal balance and adds to it due to the unpaid interest.

Cumulative negative amortization occurs when monthly payments stay consistently low until all available funds have been reduced but have not covered interest owed - thus increasing the loan's principal balance.

These two types introduce how lenders can utilize different mortgage strategies, giving buyers more options when purchasing a house or refinancing a current mortgage loan.


How Can You Avoid Negative Amorticzation?

Negative amortization can be a serious issue for homeowners, and it is important to avoid it to keep loan payments manageable. The most effective way to avoid negative amortization is to ensure that the monthly loan payments are consistently higher than the amount necessary to meet the interest portion of the repayment, which will ensure that the principal loan amount decreases over time.

For example, on a mortgage with a 30-year term, if you pay an extra $50 each month beyond what's scheduled as your regular payment amount, you will avoid negative amortization while reducing your overall loan amount by 20% faster than normal.

Doing this could save you significant amounts of money over the life of your loan in both principal and interest payments and help avoid unexpected money traps during the repayment process.


Frequently Asked Questions

Is a Negative Amortization Loan illegal?

Negative amortization loans are a type of loan with an amortization schedule that requires borrowers to pay less than the interest due each month. This means the principal amount increases over time rather than decreasing and can be an attractive payment option for many borrowers. However, is this type of loan even legal? 

The answer is yes; negative amortization loans are perfectly legal under certain circumstances for lenders to offer this type of loan and remain compliant with regulations. They must set limits on how much the balance can increase and clearly explain the terms in writing before signing any agreements.

As long as these conditions are met, borrowers have peace of mind knowing that their payments will not exceed what was agreed upon. 

Which law prohibits negative amortization loans?

Negative amortization loans can cause a lot of financial trouble for borrowers who don’t understand how they work. The Dodd-Frank Wall Street Reform and Consumer Protection Act, enacted in 2010, prevents lenders from offering these loans to consumers.

Amortization means that with each payment, the amount owed on loan goes down until it is paid off in full. However, with negative amortization loans, the amount owed increases because each payment does not cover all the interest due.

This means that instead of paying off the loan over time, borrowers are likely to owe more money than when they first got it. To protect consumers from taking on too much debt and ending up worse off than when they started, Congress passed a law prohibiting negative amortization loans as part of the Dodd-Frank Act.

Can a Student Loan Have Negative Amortization?

Student loans are a crucial component of financing for higher education. Unfortunately, with the rising cost of college tuition, many students fall into debt. Can a student loan have negative amortization? 

In short, yes. Negative amortization occurs when the loan's principal balance is not paid off enough to cover the monthly interest accrued. In this case, the unpaid interest is added onto the principal balance of the loan and thus increases it over time.

This phenomenon can also happen with fixed-rate mortgages. However, those mortgages usually come with conditions that require homeowners to make payments that cover at least some portion of their mortgage's interest so that their balances stay relatively high.

How Does Negative Amortization on a Mortgage Work?

Negative amortization is a mortgage payment option that can benefit people who want to keep their monthly payments low. This article will explain how negative amortization works and why it may be the right choice for some homeowners. 

A negative amortization mortgage allows you to make less than your full monthly mortgage payment each month, resulting in an unpaid balance that increases over time. For example, take out a 30-year fixed-rate mortgage with a 5% interest rate and a $1,000 payment.

But only pay $700 each month, the remaining $300 goes toward additional principal instead of interest. This means that while your regular payments stay at $700 per month, the amount you owe on loan grows due to accruing interest on top of the principal.



A negative amortization loan is when your monthly payments are less than the amount of interest that accrues on loan. This results in the principal balance of your loan increases over time. Negative amortization loans can be beneficial if you need lower monthly payments or want to make smaller payments at first and larger ones later on. Just keep an eye on your principal balance, so it stays manageable! Thanks for reading this ultimate guide about Negative Amortization Loan 2023.



Urban Real Estate Center

Confused about Negative Amortization Loans? This comprehensive guide will help you understand how loan balances can increase over time and what borrowers need to know before considering a negative amortization loan.