Reverse Mortgage vs. Forward Mortgage: An Overview
A forward mortgage is a mortgage loan used to purchase a home that typically involves a fixed interest rate and monthly payments. Conversely, a reverse mortgage allows homeowners 62 and older to convert their home equity into cash, getting paid by the lender via monthly payments, a credit line, or a lump sum.
With a forward mortgage, your loan balance decreases as you make payments, increasing your home equity. However, your loan balance with a reverse mortgage increases due to your withdrawals, reducing your home equity. The reverse mortgage lender also charges interest and fees that are added to the loan balance, reducing your equity. The reverse mortgage gets repaid when the homeowner passes away, sells or leaves the home.
Both forward and reverse mortgages are significant financial commitments that use your home as collateral. A homeowner might use their home as collateral twice in a lifetime, getting a forward mortgage to purchase the home and, decades later, a reverse mortgage to withdraw income from the home. Discover the similarities and differences between a forward mortgage and a reverse mortgage.
Key Takeaways
- Reverse and forward mortgages are large loans that use your home as collateral.
- Forward mortgages, more commonly just called mortgages, are loans used to purchase a home.
- Reverse mortgages, which require you to be 62 years old or older, allow homeowners with large amounts of equity in their home to borrow a lump sum or annuity-like payment.
- Reverse mortgages have no monthly payments, and the balance—plus interest—is due when the borrower dies, sells the home, or moves.
Only people aged62 and above are eligible to get a reverse mortgage.
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Reverse Mortgage
A reverse mortgage allows homeowners to withdraw their home equity value and get paid via a lender as a lump sum, monthly annuity, or line of credit. The funds from a reverse mortgage can be used without restrictions, including to pay medical expenses, debt consolidation, home repairs, and supplement income.
Reverse Mortgage Costs
The accumulated debt, interest, and fees on a reverse mortgage are due when the mortgage holder moves, sells the home, or dies. Like a traditional forward mortgage, you will pay closing costs for a reverse mortgage.
One of the costs includes the mortgage insurance premium (MIP) paid to the lender, which is 2% of the home value paid upfront at the loan closing and 0.5% of the outstanding loan balance paid annually thereafter.
Other costs include third-party charges, such as appraisal, title search, and insurance fees as well as property taxes. The lender charges an origination fee to process the loan, which is the greater of $2,500 or 2% of the first $200,000 of your home's value and 1% over $200,000 but are capped at $6,000.
Federally Regulated
The federal government regulates reverse mortgages to prevent predatory lenders from snaring senior citizens. The bank may not demand a payment that exceeds the value of the home. The bank recoups any losses through an insurance fund, which is one of the costs of the reverse mortgage.
The Department of Housing and Urban Development (HUD) oversees the most common reverse mortgage, called a home equity conversion mortgage (HECM), which is issued through private lenders but insured by the Federal Housing Administration (FHA).
Mortgage lending discrimination is illegal. If you think you've been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps you can take. One such step is to file a report to the Consumer Financial Protection Bureau or the U.S. Department of Housing and Urban Development (HUD).
Forward Mortgage
A forward mortgage is a loan used to buy a home or real estate, which is typically a fixed-rate 30-year term. As you make payments, your loan balance decreases, increasing your home equity. Other mortgage products exist that include a 15-year or 20-year term, as well as adjustable-rate mortgages that have a variable interest rate for a portion of the term.
Borrowers may get a better interest rate and save a substantial amount in interest over time if they go for a 10- or 15-year mortgage. However, the shorter the term, the higher the monthly payment. Like a reverse mortgage, the home serves as collateral for a forward mortgage loan.
Closing Costs and Down Payment
With a forward mortgage, closing costs usually include a down payment based on a percentage of the home's value. Typically, mortgage lenders require 20% down, paid at the closing.
However, programs exist for first-time homebuyers through the Federal Housing Administration (FHA), which insures mortgage loans, protecting lenders. This protection allows lenders to offer a lower down payment by as low as 3.5% for qualified buyers. The FHA insures its loans, protecting the lender, but you must go through an FHA-approved lender.
Risks of Borrowing Too Much
The mortgage system is based on the assumption that real estate increases in value over time. That truism proved false when the housing bubble burst in 2008. As of August 2022, 2.9% of American mortgaged homes—or one in 34—were still “seriously underwater,” according to an ATTOM Data Solutions survey.That means their owners must continue to pay inflated mortgages or pay their banks 25% or more above their homes’ assessed value when they sell.
Speaking of getting into trouble, during the housing boom, it became common for homeowners to obtain a line of credit, using their home as collateral in addition to their mortgages. Both the homeowners and their bankers assumed that the significant increases in home values would keep going. When the bust came, homeowners got stuck holding the double debt for the mortgage and the line of credit.
In August 2022, ATTOM Data Solutionsreleased its U.S. Home Equity and Underwater Report for the second quarter of 2022. It revealed thatunderwater properties made up 2.9% of all mortgaged properties in the U.S., down from 3.2% in the first quarter of 2022.
Reverse Mortgage vs. Forward Mortgage Example
A married couple, each about 30 years old, buys a home with a small down payment. They are promising to pay the money back in small monthly increments of principal plus interest over a period of years. Thirty years is traditionally the standard.
More than 30 years later, the same couple lives in the same house, having paid off the mortgage in full. Even with their combined Social Security benefits and retirement savings, it’s difficult to make ends meet, so they take out a reverse mortgage. They’ll pay nothing upfront and get a monthly check to supplement their income. They never pay off the mortgage or the interest and costs that accrue over the years. However, the loan must be repaid when they pass away, sell the home, or leave the home.
What Is a Forward Mortgage?
A forward mortgage, or mortgage, is a loan with a fixed rate of interest used to purchase a home. A forward mortgage loan has a fixed monthly payment, with a portion of each payment going to pay the principal (the borrowed amount) and interest. Typically, a forward mortgage has a loan term of 15, 20, or 30 years.
What Is a Reverse Mortgage?
A reverse mortgage allows those 62 years or older to take out a loan using their home as collateral. The equity or home ownership built up in your home can be cashed out via a monthly payment stream, credit line, or lump-sum payment.
Unlike a traditional mortgage, you don't make monthly payments on a reverse mortgage. Instead, you repay the loan when you sell the home, no longer live in the home, or pass away. In return, the mortgage lender charges interest and fees by adding them to the loan balance, reducing your home equity.
What Are the Downsides of a Reverse Mortgage?
The downsides to a reverse mortgage include interest and fees charged to the loan balance by the lender, which reduces your home equity. Also, the more money you get paid from a reverse mortgage, the faster your home equity decreases.
You must still pay for the property taxes, homeowners insurance, and upkeep of the property. However, the biggest downsides include running out of money or equity, and you may receive less if you sell the home due to the reverse mortgage loan balance.
The Bottom Line
With a forward mortgage, or mortgage loan, you borrow money to buy a home and, in return, make monthly payments to the lender who charges you a fixed rate of interest on the loan. Once you pay off the loan, you own the home.
Conversely, a reverse mortgage allows those 62 and older to get paid using their home's equity via monthly payments, a credit line, or a lump sum. In return, the lender charges interest and fees, which get added to the loan balance, reducing your home's equity. You repay the reverse mortgage when you sell or leave the home. Both a forward and reverse mortgage use your home as collateral for the loan.
