Negative amortization
NegAmNegative amortization is a rise in a loan's balance while payments are being made, because the payment is smaller than the month's interest and the part it does not cover is added to what is owed. The next month's interest is then charged on the larger balance.
What is negative amortization?
Amortization runs a balance down: the month's interest is charged, the payment covers it, and the rest of the payment retires principal. When the payment is smaller than the interest, nothing is left for principal, and the interest the payment did not cover is added to the balance. The balance ends the month higher than it began, and the next month's interest is charged on the higher figure, so at an unchanged payment the shortfall grows a little each month.
It happens where a payment is set by something other than the balance and the rate: a card or loan whose minimum is below the month's interest, a mortgage written to allow a payment below the interest for a period, such as a payment-option ARM, and a student loan payment set from income. Under the Consumer Financial Protection Bureau's ability-to-repay rule, a mortgage whose terms allow the balance to grow this way cannot be a qualified mortgage.
Interest capitalization is a separate event. A loan that keeps accrued interest apart from the principal, as most student loans do, lets a short payment's unpaid interest pile up beside the principal, and the principal grows only at the capitalization point, when that interest is added in one step. Negative amortization names the trend, a balance that rises with each short payment; capitalization names the moment unpaid interest becomes principal.
How negative amortization works, with numbers
A $20,000 loan at 9% APR is paid $100 a month. The monthly rate is 9% divided by 12, or 0.75%, so the first month's interest is $150. The $100 payment covers $100 of it, and the other $50 is added to the balance, which ends the month at $20,050.
The second month's interest is charged on $20,050 and comes to $150.38, so $50.38 is added. After 12 payments, $1,200 in all, the balance is $20,625.38: $625.38 higher than at the start, more than 12 times $50 because the added interest is charged interest of its own. After 24 payments it is $21,309.42. At $150 a month the balance would hold at $20,000; at $253.35 it would reach zero in ten years. The figures are this example's arithmetic.
- Balance
- $20,000
- Monthly rate (9% ÷ 12)
- 0.75%
- Interest, month 1
- $150.00
- Payment
- − $100.00
- Added to the balance, month 1
- + $50.00
- Balance after 12 payments
- $20,625.38
Why negative amortization matters
A payment below the interest has no payoff date. At an unchanged payment the balance grows every month and never reaches zero, and the gap widens as it grows: in the example the loan is $1,309.42 larger after two years of payments.
The rise also moves the payment that would stop it. Holding the balance flat takes a payment equal to the month's interest, which rises with the balance: $150 at the start of the example, $159.82 after 24 payments. When several debts share one monthly amount, a debt can grow for a while and then fall, once another debt clears and its payment moves over.
Negative amortization in Taiga Finance
Taiga Finance shows negative amortization in its debt payoff projections, at the payment the plan makes. A month's interest is the balance times the rate, divided by 12; when the payment falls short, the shortfall is added to the balance and the projection carries it forward. The “Debt payoff” planner under Scenarios lists its caveats under “What this plan doesn't capture”, and one of them, “Balance grows before it falls”, names the debts with months where the payment doesn't cover the interest.
When a balance never turns, there is no payoff month to show. On the Debt page the payoff readout's “Debt-free” reads “—”, and a “Balance grows” tile stands where “Interest left to pay” would be, its working listing the month's “Interest”, the “Payment” and what the balance “Grows” by. The debt's drawer ends its “Payoff schedule” with the same figures, down to a “Balance grows” row.
The public debt payoff calculator runs the same arithmetic without an account. The loan in the example, alone at a $100 monthly budget, reads no debt-free month and gives the reason “interest $150/mo · payment $100/mo: the balance grows $50/mo at this payment”. Beside a $2,000 card at 24% with its own $100 minimum, at a $200 budget, the loan rises to $21,409 over 26 months while the card is paid off, then falls once the card's $100 joins its payment, and the calculator notes “Balance grows before it falls”.
The public debt payoff calculator →Key takeaways: Negative amortization
- Negative amortization is a loan balance rising while it is paid, because the payment is below the month's interest and the shortfall is added to the balance.
- In the example, $100 a month on $20,000 at 9% APR leaves the balance at $20,625.38 after a year and $21,309.42 after two.
- Interest capitalization is the single event at which unpaid interest becomes principal; negative amortization is the balance rising month after month.
- Taiga Finance carries the rise forward in its payoff projections, flags it as “Balance grows before it falls”, and gives no payoff month for a balance that never turns.
Questions about Negative amortization
What is negative amortization?
A loan balance that grows while payments are being made, because each payment is smaller than the month's interest and the unpaid part is added to the balance. A $20,000 loan at 9% APR paid $100 a month is charged $150 of interest in the first month, so its balance rises by $50, and by $625.38 over the first year.
What is the difference between negative amortization and capitalized interest?
Negative amortization is the trend: a balance that rises month after month because the payments fall short of the interest. Capitalization is an event: the point, such as the end of a student loan deferment, at which interest that accrued unpaid is added to the principal in one step. A loan that keeps accrued interest apart from the principal can grow in what is owed without its principal changing until that interest capitalizes.
Does Taiga Finance show when a debt's balance is growing?
Yes, in its payoff projections. A debt whose payment falls short of the interest in some months is named under the note “Balance grows before it falls”, and a plan whose balance never turns reads no debt-free month, with a “Balance grows” figure for what it rises by each month. The public debt payoff calculator does the same without an account.