Traditional v.s. Reverse Mortgage: A Comparison
"A bird is safe in its nest—but that is not what its wings are made for." — Amit Ray, spiritual leader
While most people know something about traditional mortgages (also known as conventional mortgages), fewer understand reverse mortgages. In truth, the two financial vehicles have little in common. 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 one thing 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 bank finances the rest of the purchase price. The borrower owes the bank the amount loaned plus interest. The 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 doen’t have a fixed term. A reverse mortgage’s term is the life of the borrower or the time they live in the house. 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. Borrowers must pay property taxes and home insurance, and maintain the home.
No monthly mortgage payments. Borrowers don’t make a required monthly mortgage payment.
Payout options. A borrower can receive loan proceeds as a lump sum, monthly payments, 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.
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.
*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 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.