Reverse Mortgage vs. Traditional Mortgage: What’s the Difference?
By: Courtney Jorstad
February 10, 2023 • 8 minute read
Reverse Mortgage vs. Traditional Mortgage: What’s the Difference?
While mortgages can come in all shapes and sizes, there are two main types of mortgages: reverse mortgages and traditional mortgages. Traditional mortgages are also known as forward mortgages.
Whether you have a reverse or traditional mortgage, one thing is true about both: a mortgage is a home loan that has to be paid back. But it is also a contract with the lender and if the terms of the agreement are not met, the lender has the right to take the property.
But that’s where the similarities end. How a traditional mortgage and reverse mortgage work are very different.
Let’s figure out which one is right for you and your situation.
What is a Traditional Mortgage?
A traditional mortgage can be used by a borrower to purchase any type of real estate including a house, condominium, apartment, and land. This may include a property the borrower intends to live in, an investment property, a second home, or land that will be used at a later date.
A traditional mortgage can be obtained by both individuals and businesses.
A mortgage allows individuals and businesses to obtain property without having to pay the entire cost of the real estate up front, since home prices are typically more than what most Americans have in their bank accounts.
A traditional mortgage is paid back in the form of monthly payments over an agreed period of time, which is known as the mortgage term. Mortgage terms typically range between five years and 40 years, but most mortgages are typically paid back in 15- or 30-year terms.
Borrowers pay an interest rate on the loan amount that is paid with each mortgage payment. There are two types of interest rates: fixed-rates and adjustable rates.
A fixed-rate mortgage is the most common type of forward mortgage that borrowers use. As the name implies, with a fixed-rate mortgage, the interest rate is the same for the life of the loan.
An adjustable-rate mortgage (ARM) typically has a fixed interest rate for a specified period of time, and then it can fluctuate periodically after that. For example, an ARM may be fixed for five years and then start the adjustment period after the initial five years is over.
What Types of Traditional Mortgages Exist?
Within the forward mortgage category, there are several types of mortgages for individuals in different types of situations:
- Conventional Mortgages. This is the standard type of mortgage that isn’t guaranteed by any government agency.
- FHA Mortgages. These mortgages are insured by the Fair Housing Administration (FHA) and are typically available to first-time home buyers.
- VA Mortgages. These mortgages are backed by the U.S. Department of Veterans Affairs and are available to military members and surviving spouses.
- USDA Mortgages. These mortgages are guaranteed by the U.S. Department of Agriculture (USDA). USDA loans are for those who have low-to-moderate incomes and want to buy a home in qualifying rural areas.
How Do You Qualify for a Traditional Mortgage?
In order to obtain a traditional forward mortgage, you must meet some basic requirements. The following requirements are what you can expect for a conventional mortgage:
- Down payment. Conventional mortgages require a minimum of three percent down payment, but in order to avoid paying what’s known as private mortgage insurance (PMI), you need a 20% down payment.
- Credit Score. A conventional mortgage requires a minimum 620 credit score. The higher your credit score, the lower your interest rate.
- Income and employment. Typically, you will need to have two years of steady income.
- Debt-to-income ratio. Most lenders want borrowers to have a debt-to-income ratio (DTI) of 45% or less.
Other factors that will be considered include cash reserves, occupancy, property type, and a home appraisal.
What is the Mortgage Process?
The mortgage loan process begins before you start shopping for a home. This is the typical process for a conventional mortgage, although there may be some variations depending on the lender:
- Pre-approval. Before making an offer on a home, you typically need a pre-approval letter stating how much you are qualified to borrow.
- Make an offer. Next, you will shop for a home and make an offer.
- Apply. It’s at this point that the official mortgage loan application will be filed.
- Processing. Once the application is completed, the loan processing begins. This includes gathering documents, ordering a credit report, ordering a property inspection, and more.
- Underwriting. The underwriter reviews and approves the application and all documents and prepares the loan for closing.
- Closing. The last step is closing. This is typically done by the title company or through a real estate attorney.
From application to closing, a traditional mortgage typically takes between 30 and 60 days.
What is a Reverse Mortgage?
The most common type of reverse mortgage that is obtained is the Home Equity Conversion Mortgage (HECM). This is the type of reverse mortgage that will be highlighted in this article.
A reverse mortgage is only available to those who are a minimum of 62 years old.
By 62 years of age, most homeowners are either in or heading into retirement. They may find themselves living on a fixed income or have limited sources of income. At the same time, they have typically lived in their home for several years if not decades. This means that they have built up a lot of equity in their homes, but that also means that a large share of their wealth is tied up in their homes.
A reverse mortgage is one way to access that equity.
One main difference between a traditional mortgage and a reverse mortgage is that a reverse mortgage does not require monthly payments to pay it back.
With a reverse mortgage, the lender pays the homeowner based on the equity in the home. Homeowners can receive the money as a lump sum, a line of credit, monthly payments, or a combination of the three.
Interest rates are also charged on a reverse mortgage, but instead of paying the interest with a monthly payment, the interest is paid back when the entire loan amount is paid back. Reverse mortgage interest rates also include fixed rates and adjustable rates.
The type of interest rate you pay depends on how you decide to receive the funds.
A reverse mortgage is paid back when the homeowner leaves the home, or the home is no longer the primary residence. This typically happens when the home is sold, and the proceeds are used to pay back the loan.
How Do You Qualify for a Reverse Mortgage?
Reverse mortgages come with some unique requirements that are very different when compared to a traditional mortgage, including the following:
- Age. In order to obtain a HECM reverse mortgage, one of the homeowners must be at least 62 years old.
- Residency. The home they want to use for the reverse mortgage must be their primary residence. This means that a reverse mortgage cannot be obtained on a second home or an investment property
- Equity. The homeowners needs to have a minimum of 50% equity built up in the home.
- Property type. The home must be a single-family home, a two-to-four-unit property in which the homeowners occupy one of the units, a townhouse, an FHA-approved condominium, or a manufactured home that meets HUD’s requirements.
- Maintenance and fees. The home needs to be in good maintained condition, and homeowners must continue to maintain the home as well as pay for property taxes and insurance.
What is the Reverse Mortgage Process?
The reverse mortgage process can take up to 45 days from start to finish. While the exact process may vary from lender to lender, here is a general overview of what can be expected:
- Step 1: Talk to a licensed reverse mortgage loan officer. The first place to start is to talk to a reverse mortgage loan officer who will assess your financial situation and determine if a reverse mortgage is right for you. He or she will also be able to tell you how much you can expect to get, go over the options for receiving the money, and answer any questions.
- Step 2: Complete HUD-approved counseling. In order to officially apply for a reverse mortgage, homeowners must complete a counseling session with a third-party counselor to go over the pros and cons of a reverse mortgage. This can be done in person or over the phone.
- Step 3: Submit your application. Once counseling session is completed, you can submit file an application.
- Step 4: Get an appraisal. An appraisal will be obtained to determine the state of the home and the market value so that the lender can get an exact number of how much you will be able to receive.
- Step 5: Processing and underwriting. The application and appraisal will be processed and prepared for closing. Additional documents may be requested at this time.
- Step 5: Closing. A closing date will be scheduled, and you will sign the closing documents
- Step 6: Receive your funds. You will receive your funds as a lump sum, a line of credit, monthly payments, or a combination of the three.
The reverse mortgage process can be cancelled at any time, even within three business days after signing the closing documents.
Which One is Right for You?
Deciding to get a traditional mortgage or a reverse mortgage has a lot to do with where you are in life and what your needs are.
Are you more than 62 years old, planning to stay in your home, have significant equity, but need additional income? Then a reverse mortgage might be the solution.
If you are over 62 years of age, do not have significant equity, and plan to move soon, then a reverse mortgage may not be the best option.
And if you are well under 62, and looking to grow your wealth through your current home and/or additional investment properties, then a traditional mortgage may be the way to go.