What occurs when monthly payments do not fully cover the interest and do not pay any principal?

When monthly payments do not completely cover the interest amount on a loan and no principal is paid down, the result is known as negative amortization. In this scenario, the outstanding balance of the loan actually increases over time. This occurs because the unpaid interest gets added to the principal balance, meaning that the borrower may end up owing more than the original amount borrowed.

Negative amortization typically happens in certain types of loans, such as some adjustable-rate mortgages or special payment options where borrowers can choose to pay less than the required interest. This can be risky for borrowers, as it leads to an increasing debt and potential difficulty when repaying the total loan amount.

Understanding this concept is critical for real estate professionals, as negative amortization can significantly impact the financial health of borrowers and their ability to manage their loans effectively.