Which type of loan is MOST likely to create negative amortization?

The type of loan most likely to create negative amortization is a graduated payment mortgage. In a graduated payment mortgage, the borrower’s payments initially start out lower than they would be under a traditional fixed-rate mortgage; these payments increase gradually over a set period, which is typically a few years.

If the initial payments are not sufficient to cover the interest accrued on the loan, the unpaid interest will be added to the principal balance, leading to negative amortization. This means that even as the borrower makes payments, the overall debt can increase because the amount owed is growing faster than it's being paid down.

Interest-only mortgages and balloon mortgages can also lead to complications or the need for larger future payments but do not inherently create negative amortization like a graduated payment mortgage does during its initial phase. Fixed-rate mortgages typically have consistent payments that cover both principal and interest, preventing negative amortization altogether.