What constitutes a "negative amortization"?

Negative amortization occurs in a scenario where the payments made on a loan are insufficient to cover the interest that has accrued. As a result, the unpaid interest is added to the principal balance of the loan, leading to an increase in the total amount owed over time. This situation is particularly relevant in certain types of loans, such as adjustable-rate mortgages or some student loans, where borrowers may initially pay lower amounts that don’t cover the full interest.

This concept is vital in lending practices, as it can lead to considerable financial implications for borrowers. Borrowers may find themselves owing more than they initially borrowed, which can create difficulties when trying to refinance or sell the property since the increased balance can exceed the value of the asset.

In contrast, the other scenarios mentioned would not fit the definition of negative amortization. For example, when a loan balance decreases over time, loan payments exceed the interest owed, or a method of refinancing a loan is used, these all indicate positive amortization or other financial arrangements, where the debt responsibility is being managed effectively.