This means that even though a future interest rate would be established by adding the margin to the index rate, the amount that the monthly payment can increase would be limited as well. Because payment caps limit only the amount of payment increases, and not interest rate increases, payments sometimes do not cover all of the interest due on your loan. This means that the interest shortage in your payment is automatically added to your debt, and more interest may be charged on that interest. You might therefore owe the lender more later in the loan term than you did at the start. This is called negative amortization.
Some mortgages contain a cap on negative amortization.
When the point is reached, monthly payments may be set to fully repay the loan over the remaining term and you payment cap may not apply. You may limit negative amortization by voluntarily increasing your monthly payment. Negative amortization can put you in a very leveraged position and may make it difficult to sell your home in the future, particularly if you have made a small downpayment and the loan balance increases faster than home values in your area. Be sure to ask you lender whether negative amortization can occur before deciding which ARM loan is best for you. Some lenders may require you to pay special fees or penalties if you pay off the ARM early.