While most people know something about traditional mortgages (also known as conventional mortgages), fewer understand reverse mortgages. In truth, the two financial vehicles aren’t the same. Trying to explain one in the context of the other is a little like explaining an apple in the context of an orange. However, there is a component that traditional and reverse mortgages have in common: they are mortgages.
What is a mortgage?
A mortgage is an agreement between a borrower and a lender that uses the home as collateral. Borrowers with any mortgage own their homes, but they are still responsible for paying the lender back. Different types of mortgages have different terms, but the outcome of not upholding them is the same for all mortgages. If the borrower does not comply by the terms, the lender will take possession of the home.
How a traditional mortgage works
A borrower with a conventional mortgage makes a down payment, and the lender finances the rest of the purchase price. The borrower owes the lender the amount loaned plus interest. They pay the loan amount in monthly installments over a fixed period of months. Earlier in the loan, more of the monthly payment goes toward the interest. Over time, as the principal decreases and the relationship between the interest and the principal switches. Because the principal amount is lower, the interest is also lower. Now monthly payments include less interest and more principal. Assuming the borrower does not refinance, they will fully own the home by the end of the term.
How reverse mortgage terms are different
Reverse mortgages have a different structure than traditional mortgages. A reverse mortgage doesn’t have a fixed term. A reverse mortgage’s term is the life of the borrower or the time they live in the house as long they comply with the loan requirements. Rather than paying off the mortgage over time, interest accrues on the balance every month. No mortgage payments are due until the end of the loan.
Here are other key ways in which a reverse mortgage is different:
- Eligibility requirements. To take a reverse mortgage, a borrower must be 62 or older for a home equity conversion mortgage (HECM). Proprietary reverse mortgages may have lower age requirements.
- Equity. Borrowers must have substantial equity in the home.
- Counseling. Borrowers must attend third-party counseling from a HUD-approved lender.
- Requirements to maintain the loan. The mortgaged home must be the borrower’s primary residence.
- No monthly mortgage payments. Borrowers don’t make a required monthly mortgage payment. Borrowers must pay property taxes and home insurance and maintain the home.
- Payout options. A borrower can receive loan proceeds as a lump sum, monthly payouts, a line of credit, or a combination.
- No fixed term for the loan. A reverse mortgage’s term is for the borrower’s life or the time they live in the house as long as they comply with the loan terms.
- Interest paid at the end. Interest accrues on the loan balance every month over the life of the mortgage. Borrowers don’t make required mortgage payments until the end of the loan.
Key Differences Between Conventional and Reverse Mortgages
Looking at features of the two loan types side by side can help borrowers understand how they differ from one another.
| Conventional Mortgage | Reverse Mortgage | |
|---|---|---|
| Age Requirement | Applicants must be of legal age to sign the contract. | Borrowers must be 62 or older to qualify for a HECM. |
| Credit Score | Minimum determined by lender. | No minimum credit score is required for a HECM. |
| Financial Obligations | Monthly payments are required every month with interest. | Balance plus interest is due when the borrower dies, moves, or sells the home The amount the borrower owes to the lender goes up over time because of interest and fees added to the loan balance each month. |
| Loan Term | Borrowers can choose a loan with a 10, 15, 20, or 30-year term. | No fixed term. |
| Interest Rate | Fixed or adjustable rates are available. | Fixed interest rate only available for lump sum option. Other payment disbursements available with an adjustable rate. |
| Interest Payment | The borrower pays interest monthly. As payments are made over time, less money will be applied toward interest. | Interest is charged to the balance monthly, but not due until the end of the loan. The total amount owed grows as interest adds up. |
| Monthly Payment | Monthly payments are required with interest.Payments will be applied toward interest and principal. | No monthly mortgage payments required*. |
| Loan Disbursement | Most traditional mortgages don’t have any disbursement. In the case of a cash-out refinance, disbursement is a single, lump sum payment. | Borrowers can receive disbursements as a lump sum, monthly payout, line of credit, or some combination of these options. |
| Counseling Requirement | No counseling is required. | Third-party counseling is required with a HUD-approved counselor for HECMs and proprietary mortgages. |
| Loan Maintenance | No requirement to pay dues or maintain the loan. If monthly payments are made to the lender, the borrower is current with the loan. | The borrower must live in the home, maintain the home, and pay applicable property taxes, insurance and dues associated with homeownership. |
Conventional MortgageApplicants must be of legal age to sign the contract.
Reverse MortgageBorrowers must be 62 or older to qualify for a HECM.
Conventional MortgageMinimum determined by lender.
Reverse MortgageNo minimum credit score is required for a HECM.
Conventional MortgageMonthly payments are required every month with interest.
Reverse MortgageBalance plus interest is due when the borrower dies, moves, or sells the home The amount the borrower owes to the lender goes up over time because of interest and fees added to the loan balance each month.
Conventional MortgageBorrowers can choose a loan with a 10, 15, 20, or 30-year term.
Reverse MortgageNo fixed term.
Conventional MortgageFixed or adjustable rates are available.
Reverse MortgageFixed interest rate only available for lump sum option. Other payment disbursements available with an adjustable rate.
Conventional MortgageThe borrower pays interest monthly. As payments are made over time, less money will be applied toward interest.
Reverse MortgageInterest is charged to the balance monthly, but not due until the end of the loan. The total amount owed grows as interest adds up.
Conventional MortgageMonthly payments are required with interest.Payments will be applied toward interest and principal.
Reverse MortgageNo monthly mortgage payments required*.
Conventional MortgageMost traditional mortgages don’t have any disbursement. In the case of a cash-out refinance, disbursement is a single, lump sum payment.
Reverse MortgageBorrowers can receive disbursements as a lump sum, monthly payout, line of credit, or some combination of these options.
Conventional MortgageNo counseling is required.
Reverse MortgageThird-party counseling is required with a HUD-approved counselor for HECMs and proprietary mortgages.
Conventional MortgageNo requirement to pay dues or maintain the loan. If monthly payments are made to the lender, the borrower is current with the loan.
Reverse MortgageThe borrower must live in the home, maintain the home, and pay applicable property taxes, insurance and dues associated with homeownership.
*Reverse mortgage borrowers don’t make required monthly mortgage payments. However, they are still responsible for all property taxes, insurance, and other fees and dues associated with homeownership (i.e., HOA dues).
How to decide which mortgage is right for you
Because reverse mortgages are only available to people of a certain age, many people don’t have them as an option. If you are eligible, here are a few reasons why you may choose a reverse mortgage over a traditional one. A reverse mortgage has certain key advantages:
- No required monthly payments. Borrowers can increase their cash flow by eliminating monthly mortgage payments.
- Leverage your equity. Borrowers can liquidate their equity.
- Spend funds any way you like. There are virtually no limitations on the use of funds. Proceeds can be used for medical expenses, home improvement projects, vacations, or anything else the borrower chooses.
- Line of credit grows. If borrowers choose a line of credit, their borrowing power may increase over time, even if the home depreciates in value.
- Nonrecourse loan. Heirs or borrowers never have to owe more than the home’s value or balance. No other assets will be touched to make up a difference in the value of the home and the loan balance.
When choosing between a traditional vs. a reverse mortgage, it’s a great idea to consult with a financial advisor.
