Positive Amortization
-
Definition: Most common in standard loans, positive amortization occurs when each loan payment covers all the interest due plus some of the principal (the amount you borrowed).
-
Result: Over time, your loan balance decreases with each payment until it is fully paid off.
-
Example: Traditional home mortgages, auto loans, and student loans usually follow positive amortization schedules.
Negative Amortization
-
Definition: Negative amortization happens when your monthly loan payment is less than the interest charged for that period. The unpaid interest gets added to the loan balance.
-
Result: Your loan balance increases over time, instead of going down.
-
Example: Some adjustable-rate mortgages or special loan programs may allow for negative amortization, but it can be risky since you end up owing more than you originally borrowed.
Key Differences at a Glance
| Feature | Positive Amortization | Negative Amortization |
|---|---|---|
| Loan balance over time | Decreases | Increases |
| Interest payment | Fully paid each month | Not fully paid; unpaid added |
| Risk | Lower | Higher, can lead to larger debt |
| Common in | Standard loans | Some ARMs, specialty loans |
Why Does It Matter?
-
Positive amortization is safer for borrowers, ensuring debt is paid off over time.
-
Negative amortization can be risky and should be used with caution, as debt can grow instead of shrink.