Negative amortization is when the borrower's payment is less than the accrued interest and the difference is added to the loan balance.

The concept is simple. In practice, it gets tricky very fast.

The primary reason negative amortization exists is to reduce the initial mortgage payments. The booby trap of negative amortization is that THE PAYMENT MUST INCREASE AT SOME POINT in the life of the mortgage. The resultant payment shock is proportionate to the amount of negative amortization and the period over which it occurs. Thus, the more attractive the loan is upfront to the borrower (lower payments = more negative amortization) the larger payment shock will need to be to fully amortize the loan.

This type of loan has many names, but they all operate roughly the same. These loans have also been called, Negative Amortizing Loan ("Neg Am" or "Negam"), Pick-A-Payment loans, and Deferred Interest Option Loan.