What type of mortgage allows for negative amortization?

Certain adjustable-rate mortgages (ARMs) with specific features allow for negative amortization because they are structured in such a way that the monthly payments may not cover the full interest due on the loan. This can result in the loan balance increasing over time rather than decreasing, as the unpaid interest is added to the principal balance. These ARMs often include features such as payment caps or the ability to make minimum payments that are lower than the accruing interest.

This arrangement can be appealing in situations where initial lower payments are necessary, but it carries significant risks since the borrower can end up owing more than the original loan amount if property values do not increase or if the borrower does not refinance or pay off the loan before the rate adjustments or payment increases lead to higher monthly payments.

Fixed-rate mortgages and conventional loans typically do not allow for negative amortization, as their payment structures are designed to fully repay the loan according to a pre-determined schedule. Government-backed loans also generally follow similar amortization rules that prevent negative amortization, ensuring the borrower pays off the loan within the specified term. Thus, the unique characteristics of certain ARMs make them the correct choice for allowing negative amortization.