Reverse Mortgage vs. Forward Mortgage: What’s the Difference?

Reverse Mortgage vs. Forward Mortgage: An Overview

If you’ve never heard of a forward mortgage, there’s a reason for that. The term refers to traditional mortgages and is rarely used, except in comparison with a reverse mortgage. Whether you go with a forward or reverse mortgage depends upon where you are at this point in your life—personally and financially.

If you are under 62, the closest equivalent to a reverse mortgage is a home equity line of credit (HELOC). This is a set amount of money that you can draw upon at any time, for any reason. However, your home acts as collateral for a HELOC.

Both forward and reverse mortgages are essentially huge loans that use your home as collateral—and they’re major financial commitments. A couple might use a single home as collateral twice in a lifetime, getting a forward mortgage at purchase and then, decades later, a reverse mortgage.

Reverse Mortgage

Reverse mortgages are regulated by the federal government in order to prevent predatory lenders from snaring senior citizens. However, the government can’t prevent senior citizens from fooling themselves.

Homeowners can get the entire amount of the loan as a lump sum at settlement, with no restrictions on its use. The expectation is that they will pay off their outstanding debts and use any remaining funds to supplement other sources of income. Homeowners may also opt to get the money as a monthly annuity or line of credit.

The accumulated debt and interest on a reverse mortgage, plus costs, is due when the mortgage holder moves, sells the home, or dies. This could mean the heirs have to pay the loan.

There is one consumer-friendly note: the bank may not demand a payment that exceeds the value of the home. The bank recoups the loss through an insurance fund that was one of the costs of the reverse mortgage. The Department of Housing and Urban Development (HUD), which oversees the dominant reverse mortgage program, moved in the fall of 2017 to shore up that insurance fund.

Forward Mortgage

Compared to the typical 30-year mortgage, 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, that takes a fair degree of confidence that your income and expenses will stay steady or improve in the years to come.

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 Solutions released its U.S. Home Equity and Underwater Report for the second quarter of 2022. It revealed that underwater 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 is living 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. In fact, they never pay off the mortgage or the interest and costs that accrue over the years. However, their heirs must do so in the future, either by selling the family home or with a lump sum.