Negative Amortization

Negative Amortization — under normal amortization, each payment covers the month's interest with the remainder reducing principal. Negative amortization reverses this dynamic. When payments fall short of the interest due — whether by loan design, as with certain adjustable-rate products, or because of a payment cap — the shortfall is tacked onto the loan balance. The borrower ends up owing more than they originally borrowed.

Note investors encounter negative amortization most often in legacy adjustable-rate mortgages and in non-performing loans where partial payments were accepted over an extended period. A growing balance erodes equity and increases the likelihood that the borrower is underwater, which complicates resolution strategies. During due diligence, investors should recalculate the true unpaid principal balance to account for any negatively amortized interest before pricing the note.