What is the primary risk involved with a negative amortization loan?

A negative amortization loan presents a unique risk primarily due to the way payments are structured. In this type of loan, the monthly payments may not cover the full amount of interest that accrues during that period. As a result, any unpaid interest is added to the principal balance, leading to an increase in the total amount owed over time. This phenomenon creates a situation where the borrower could end up owing significantly more than the original loan amount despite making regular payments.

Understanding this concept is crucial for borrowers and lenders alike, as it highlights the importance of payment structures and the potential long-term financial implications of choosing certain loan products. It protects borrowers from falling into a deeper debt trap and encourages them to thoroughly assess their repayment abilities before committing to a loan that could lead to unwanted financial strain.