Because homeowners want to pay off their mortgage loan within the loan term, many try and avoid negative amortization. Instead, they prefer mortgage options which will result in a fully amortization loan. Amortization is simply the reduction of the principal balance. When a borrower makes a mortgage payment, a portion of the funds is the interest due, and the other portion reduces the amount owed to the lender. On fixed rate mortgages, the loan will be fully amortized. For the 30 year term, the borrower will pay an equal, predictable amount to reduce both the principal and interest, which keeps the loan on schedule for repayment. Then again, if a borrower chooses certain types of adjustable rate mortgages, the loan may have a negative amortization.

Before a monthly payment is applied to the principal balance, the lender will apply a portion of the payment to the interest. During the initial payment years, only a small amount of the mortgage payment reduces the principal. For example, if the mortgage payment is $700, the interest due may be $550, thus the principal balance is only reduced by $150.

Because some buyers choose home loan programs which offer low initial payments, the mortgage payment may be less than or equal to the interest due. If so, the remaining balance is tacked onto the principal. Considering the above example, if the interest due is $550, and the monthly mortgage payment is also $550, there is no reduction of the principal balance or amortization. Going a little further, if the borrower cannot afford a $550 mortgage payment and only pays $500 a month for the loan, the payment is less than the interest due. Not only is there no amortization of the principal balance, but the interest not paid is added to the loan balance. In this case, the loan balance at the end of the month will increase and negative amortization occurs.

Many homebuyers do not fear negative amortization because future adjustments will result in a fully amortized loan. Regrettably, borrowers encountering negative amortization will experience higher mortgage payments in the future. This way, the loan can become fully amortized before the payoff date. In some housing markets, negative amortization is equalized by rising home values. On the downside, if home values decline and a borrower is not making fully amortizing payments, the home may gain little or no equity.