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

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

For most people who want to own a home one day, getting a traditional mortgage becomes their only option. However, the United States is currently under a real estate boom with soaring home prices. As such, a large portion of the population can only afford to wait for a market crisis to qualify for a traditional mortgage from the bank. And most of the younger generation’s parents are continuing to pay for their mortgage loan balance into their late 60s. 

Many private lenders and other financial institutions now offer reverse mortgages to fill a market demand for affording a home and navigating retirement living for seniors. In this article, our reverse mortgage specialists at Smartfi Home Loans will explain the difference between traditional mortgages and reverse mortgage loans.

Traditional Mortgage vs. Reverse Mortgage: An Overview

The reverse mortgage loan refers to one of the newer offerings from the lending industry. They were introduced in the late 1980s and the first FHA-insured HECM was issued in 1989. In comparison, the traditional 30yr fixed was officially authorized by Congress in the late 1940s. Much like emerging financial instruments, such as cryptocurrency and various lines of credit, the real estate market has had a healthy skepticism about its legitimacy. 

What Is a Conventional Mortgage?

Traditional or conventional mortgages have been around forever, but taking out a reverse mortgage loan was unheard of until the early 2000s. 

A conventional mortgage loan is a conforming loan, which means it meets the specific lending and underwriting requirements of Fannie Mae or Freddie Mac. 

With a conventional mortgage, the homeowner borrows money from the bank to buy or refinance a home. At that point, the borrowers then have a specific monthly mortgage repayment (principal & interest) to the lender over a specific period of time or “term.” Most common terms are a 15 or 30 year mortgages. 

Reverse Mortgage Line of Credit vs. a Home Equity Loan

Reverse mortgage loans allow seniors to open a line of credit, or to take out a lump sum of money, against their home’s equity, giving them access to tax-free cash from the equity built up in their home. In simple terms, reverse mortgage loans allow the homeowner to borrow against the equity in their home. Their loan proceeds will go directly into their pocket to use however they wish. 

Reverse mortgages are unique, and they differ from a home equity line of credit, or HELOC, in a number of ways. While both instruments allow the homeowner to borrow against the equity in their home, they have to be a senior to qualify for a reverse mortgage. Also, with a HELOC, the money they borrow comes with a minimum monthly repayment requirement; whereas a reverse mortgage line of credit allows them to defer the repayment. This payment optionality feature can lead to an increase in cash flow for retirement. 

Traditional Mortgage

Traditional mortgages, also called conventional mortgages and forward mortgages, are loans that don’t require backing from a federal government agency. Just 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, they can apply for a conventional mortgage as soon as they turn 18, provided they fulfill the requirements of their chosen lender. With traditional mortgages, the homeowner can shop around and compare private lenders to get the best loan agreement possible. 

Generally, unless the borrower’s parents gift them a free-and-clear home in their will, or they strike gold in cryptocurrency or some other business, a traditional mortgage remains the most time-efficient way of building home equity. 

When the homeowner obtains a mortgage from a lending institution, they co-own the home and typically have little to no equity in it to start. As they make their monthly payments, they decrease the loan amount owed to the lender and start to build home equity. The more money they put into their home, the more equity they build. 

Some people may get a traditional mortgage later in life, or end up carrying their debts past their working age, causing strain over their required monthly mortgage payments and little retirement income. If that sounds like your client, a reverse mortgage may be a good option for them to alleviate some of the burden and allow them to enjoy their retirement years. 

Reverse Mortgage

Unlike a conventional mortgage, some reverse mortgages have backing from government institutions, such as the Federal Housing Administration (FHA). The FHA will only insure a home equity conversion mortgage or HECM loan. These loans make up more than half of the reverse mortgage market in America, as retirement becomes more expensive. 

Reverse Mortgage Requirements

If the homeowner’s debt management agency recommends them to get a reverse mortgage, they might already meet the qualifications. However, if they want to proceed on their own, let’s review some general requirements that must be met: 

• The borrower must be at least 62 years old for a HECM. 
• The borrower must be the titleholder. 
• The borrower must have a substantial amount of equity in their home. 
• They must be able to pay the ongoing property taxes,  homeowners’ insurance, and any HOA fees throughout the mortgage period. 
• The borrower must own the property and live in it as their primary residence (meaning they reside at the property consecutively for six months and one day per year). 
• They must obtain an acceptable appraisal (done during the loan application process). 

Types of Reverse Mortgages

Knowing which type of reverse mortgage to get can make a huge difference. Hundreds of lenders across the United States offer reverse mortgages, here are few types to familiarize your client with. 

Single Purpose Reverse Mortgage

Single-purpose reverse mortgages allow seniors to draw a lump sum amount from their equity for a singular, agreed-upon purpose. They can use these funds for home repairs, mortgage insurance payments, or fulfillment of property taxes. 

If borrowers use their reverse mortgage funds for an alternate purpose, they will be liable for fraud. Local government agencies and nonprofits back single-purpose reverse mortgages, so borrowers enjoy lower fees and interest rates. 

Home Equity Conversion Mortgages

A home equity conversion mortgage loan has backing from the Department of Housing and Urban Development, and they’re federally insured. The borrower can use the funds from their HECM for any purpose. 

The government requires people applying for a home equity conversion mortgage to undergo counseling for a small fee, which they can pay using their loan proceeds. These counseling sessions answer questions, such as “How does a reverse mortgage work?” “Is a reverse mortgage a good idea?” and “Can I find more cost-efficient reverse mortgage alternatives?” 

When a lender approves the homeowner’s HECM, they can choose between an array of installment options. These options include a tenure payment configuration, where the lender gives the borrower an agreed-upon lump sum every month for as long as they live in the home, and a term option that gives them cash payments for a pre-set timeframe. Other disbursement options may be available. 

Proprietary Reverse Mortgages

A proprietary reverse mortgage helps people with larger estates obtain home equity loans that bypass the $1,149,825 lending limit of HECMs. 

If the borrower chooses this route, they will not have federal insurance, which means they might be able to borrow more without paying mortgage premiums. The details of this reverse mortgage depends on the interest rates they get, their age, and their income bracket. 

Traditional Mortgage vs. Reverse Mortgage: Which One Is Right for Your Client?

Speak with your Account Executive to do a side-by-side comparison of a traditional and reverse mortgage solution to help determine which mortgage is right for your client.

Call Smartfi Home Loans today at (877) 816-6706 or reach out through our website for more information on reverse and conventional mortgages, or to become a partner.