Negative amortization happens when you owe more money on a loan over time, instead of less. It's like borrowing money and paying so little each month that your unpaid interest gets added to the loan balance, making it grow bigger.

Here’s an example:

Imagine you borrow $1,000 with an interest rate of 5% per year. Normally, you’d make payments that cover both the interest (the cost of borrowing) and some of the loan itself. But if you only pay $20 a month when the interest costs $25, the extra $5 is added to your loan. Now you owe $1,005 instead of $1,000.

Why does this happen?

• You’re allowed to make smaller payments than the loan requires.

• Your payments don’t fully cover the interest.

Why is it risky?

• Your debt keeps growing, making it harder to pay off later.

• You could end up owing more than the item you financed is worth (like a car or a house).

When does this happen?

Negative amortization is common in loans like adjustable-rate mortgages (ARMs) or student loans with income-driven repayment plans where your payment might be low at the start. It’s a tool that can help in the short term, but it can be dangerous if you don’t fully understand it.