Negative Amortization

Negative amortization summary:

• Negative amortization is when your loan balance grows bigger because your payments aren’t big enough to cover all of the interest.

• Negative amortization typically happens during loan deferment.

• Negative amortization is common for unsubsidized student loans.

Negative Amortization Definition and Meaning

Negative amortization is when your loan payments don’t cover interest. It typically happens when you defer or pause loan payments.  

Some lenders let you pause payments on credit cards, student loans, or mortgages, but oftentimes, you’re still on the hook for interest. Your monthly payments are paused (deferred), but during the pause, interest is added to your principal. That means your loan balance gets bigger over time. Also, you’ll pay interest on the new, larger balance.

Key Components of Negative Amortization

• Rising loan balances: Your loan balance rises because payments don’t outpace interest.

• Temporary pauses or reductions: Negative amortization is typically temporary. In the long run, it’s unsustainable, and neither you nor the lender benefit from a default.

Amortization is the process of paying down your loan balance. Negative amortization is the same process, except interest grows faster than you pay it down.

Types of Negative Amortization Situations

Credit card forbearance, student loan deferment, and mortgage forbearance are three situations that sometimes lead to negative amortization. 

Credit card forbearance pauses or reduces monthly payments, typically as part of a hardship program. If you don’t pay enough to cover the interest, your balance will grow. 

Student loan deferment pauses monthly payments. This is common while you’re in school full time and payments aren’t required, for example. During the pause, you’re still charged interest on your loans. The government pays the interest on subsidized student loans. But you are responsible for paying the interest on unsubsidized federal loans and private student loans, even if you’re in school. If you don’t, your loan balance will grow.

Mortgage forbearance pauses or shrinks monthly payments, again, typically as part of a hardship program. Interest still accrues, and if you're not paying it, the unpaid interest gets added to your principal. This leads to negative amortization, potentially making your home loan balance bigger.

How to prepare for mortgage forbearance

Ask your lender to explain your mortgage forbearance agreement in plain language before you move forward. You’ll want to understand exactly what you’re getting into, including how much extra you’ll pay (eventually) if your loan experiences negative amortization. 

What to ask lenders:

• How much do I pay during forbearance? 

• How does interest add up during forbearance?

• When and how do I repay paused or reduced payments?

Your lender could ask you to get caught up on paused payments immediately after the forbearance ends. Or they might add payments to the end of your mortgage repayment period. Or they might spread the extra payments out during the course of your mortgage. Ask your mortgage lender for details so you know what to expect.

Example of Negative Amortization

Student Loan Deferment: Say you have a $10,000 student loan at 5% interest and skip payments for a year while you’re enrolled in school. Interest adds $500 to your balance, growing it to $10,500. That’s negative amortization. If you defer for another year, you’ll pay interest on the higher balance.