Negative amortization is a type of loan where the outstanding principal balance of the loan increases over time, instead of decreasing like with a normal amortizing loan. This is because the principal payments are less than the interest payments due on the loan. The amount of principal payments outstanding is then added to the loan balance, and the loan balance increases.

Negative amortization is most commonly seen with adjustable-rate mortgage loans, although it can also be found with auto loans, credit cards, and student loans. These loans often come with a initial period at a low interest rate and no principal payments, where interest payments are much lower than the amount of interest due. The remaining unpaid interest is then added back to the principal, so the principal balance increases over time. This can help borrowers who cannot afford to make normal principal payments in the short term.

However, the added flexibility of negative amortization comes at a price. Borrowers can end up with a much higher loan balance than they started with, and the interest rate or repayment terms of the loan can change significantly over the life of the loan. This can expose the borrower to further financial risk and lead to a loan balance that is larger than expected.

For this reason, it is important to understand the potential consequences of negative amortization when looking into loan options. Borrowers should study the loan documents carefully to ensure they are comfortable with the repayment terms and aware of any potential changes down the line. As long as borrowers understand the risks associated with negative amortization loans and make sure to pay as much as possible towards principal each month, these loans can offer additional flexibility for short-term cash flow issues. It is important to weigh the costs and benefits before entering into a negative amortization loan agreement.