Traditional vs. Reverse Mortgages: What’s the Difference?

Traditional Mortgages vs. Reverse Mortgages: What's the Difference?

For many aspiring to own a home, a traditional mortgage is often their only path to homeownership. However, with the current real estate boom in the United States driving home prices to new heights, a significant portion of the population finds themselves unable to afford a home without waiting for a market downturn to qualify for a traditional mortgage. At the same time, many parents of the younger generation are still paying off their mortgages well into their late 60s.

To meet the growing demand for housing and to help seniors navigate retirement, many private lenders and financial institutions now offer reverse mortgages. In this article, our reverse mortgage specialists at Smartfi Home Loans will explore the key differences between traditional mortgages and reverse mortgage loans.

Traditional Mortgage vs. Reverse Mortgage: An Overview

The reverse mortgage loan was first introduced in the late 1980s, with the first FHA-insured Home Equity Conversion Mortgage (HECM) issued in 1989. The traditional 30-year fixed mortgage was officially approved by Congress in the late 1940s. Similar to emerging financial products, such as cryptocurrency and various lines of credit, the real estate market has initially approached reverse mortgages with caution. However, since their introduction, significant improvements have been made to the loan structure to better protect borrowers.

What is a Conventional (or Traditional) Mortgage?

A conventional mortgage, also known as a traditional mortgage, is a conforming loan, meaning it meets the specific lending and underwriting standards set by Fannie Mae or Freddie Mac. With a conventional mortgage, the homeowner borrows money from a bank to either purchase or refinance a home. In return, the borrower agrees to make regular monthly payments (covering both principal and interest) to the lender over a fixed term, typically 15 or 30 years.

Traditional mortgages do not require funding from a federal government agency. Like reverse mortgages, traditional mortgages require the homeowner to pay property taxes, mortgage insurance premiums (if applicable), and homeowners insurance. However, unlike a reverse mortgage, individuals can apply for a conventional mortgage as soon as they turn 18, provided they meet the lender's requirements.

In most cases, unless the borrower receives a home as a gift from their parents in their will or comes into a large sum of money through other means like cryptocurrency or business ventures, a traditional mortgage remains the most efficient way to build home equity over time.

When a homeowner obtains a mortgage, the lender holds a claim to the property until the loan is fully repaid. The homeowner has the right to live in and use the property, but the lender retains a legal interest (via a lien) as collateral for the loan. As they make monthly payments, they reduce the loan balance and gradually build equity in the home. The more they pay down the loan, the more equity they accumulate.

For some individuals, particularly those who take on a mortgage later in life or carry debt into retirement, monthly mortgage payments can become a financial strain. If this sounds familiar and you are over the age of 62, a reverse mortgage could be a viable solution to help reduce this burden and allow you to enjoy your retirement years with less financial stress.

What is a Reverse Mortgage?

A reverse mortgage is a specialized loan designed for senior homeowners, age 62 and over, that allows them to access a portion of their home’s equity. Sometimes referred to as Home Equity Conversion Mortgages (HECMs), reverse mortgages provide homeowners with tax-free² cash that can be used for various purposes, such as lifestyle enhancements or medical expenses.

Just like with a traditional mortgage, the home serves as collateral, but unlike a traditional mortgage, the borrower is not required to make monthly payments.* The reverse mortgage remains in place as long as the borrower continues to live in the home as their primary residence and all loan terms are met.

With a reverse mortgage loan, you can choose how you want to receive your loan proceeds. Lenders typically offer several disbursement options, including:

• A lump sum payment, where you receive the entire amount of the loan at once
• A line of credit that allows you to withdraw funds as needed
• Monthly payments for a specific period or for as long as you remain in the home
• A combination of the above options, offering maximum flexibility. For instance, you could take a small lump sum upfront, receive monthly payments, and keep a line of credit available for unexpected expenses

Some traditional and reverse mortgages have backing from government institutions, such as the Federal Housing Administration (FHA). These loans make up more than half of the reverse mortgage market in America, as retirement becomes more expensive.

To be eligible for a HECM reverse mortgage, as a borrower:

• You or your spouse must be age 62 or older (a non-borrowing spouse may be under age 62)
• You must own your home and live in it as your primary residence
• You must have sufficient equity in your home
• You must pass product specific residual income and credit requirements
• You must complete reverse mortgage counseling by an independent, HUD-approved counselor

Proprietary Reverse Mortgage

Proprietary reverse mortgages work by converting some of your home’s equity into non-taxable² cash. These are private loans from the lender, rather than by federal or local government agencies. Because they are not federally insured, proprietary reverse mortgages do not adhere to the limits and requirements set by the Federal Housing Administration (FHA). However, third-party counseling is still required for these privately funded loans. This is to ensure that you fully understand the loan's costs and financial implications, helping you make an informed decision.

One of the key advantages of a proprietary reverse mortgage is the potential to borrow more money than with a federally insured reverse mortgage. This is particularly beneficial if your home has a high appraised value and a low mortgage balance. In such cases, you could receive a larger loan advance through a proprietary reverse mortgage.

Single Purpose Reverse Mortgage

The most economical option for homeowners is the single-purpose reverse mortgage. These loans are typically offered by state and local government agencies, as well as non-profit organizations, to homeowners with low or moderate incomes. However, they are not as widely available as other reverse mortgage options.

As the name implies, a single-purpose reverse mortgage can only be used for one specific purpose, unlike other reverse mortgage types that offer more flexibility in how the funds are used. The lender will specify how the funds must be spent, such as for home improvements, property taxes, or essential home repairs.

Home Equity Conversion Mortgage (HECM)

The most popular reverse mortgage option is the Home Equity Conversion Mortgage (HECM). HECMs are federally insured reverse mortgages, insured by the Department of Housing and Urban Development (HUD). Unlike a single-purpose reverse mortgage, a HECM offers more flexibility, allowing you to use the funds for almost any purpose.

Before pursuing a HECM, there are several factors that will determine how much you can borrow based on your home’s equity, including:

• Loan interest rates
• The appraised value of your home or max claim amount, which is $1,209,750 (as of January 1, 2025)
• The age of the youngest borrower or non-borrowing spouse

Additionally, obtaining a HECM requires reverse mortgage counseling. This is to ensure that you fully understand the loan's costs and financial implications, helping you make an informed decision.

There are several disbursement options available with a HECM:

• Fixed monthly cash payments for a set period
• Fixed monthly cash payments for as long as you live in the home
• A line of credit, allowing you to withdraw funds as needed for any purpose
• A single lump sum cash disbursement
• A line of credit with scheduled payments

There are limits on how much you can borrow during the first year, known as the initial principal limit. In most cases, you can access up to 60% of your initial principal limit within the first 12 months.

Below is a comparison chart outlining the key differences between a reverse mortgage and a traditional mortgage: