The decline of episodic memory is perhaps the most detrimental consequence of cognitive aging. However, when to-be-remembered information is in line with one’s prior knowledge, or schema-congruent, older adults often show no impairments. There are two major accounts of these effects: One proposes that schemas compensate for memory failures in aging, and the other proposes that schemas instead actively impair older adults’ memory for incongruent information. However, the evidence thus far is inconclusive, likely due to methodological constraints in teasing apart these complex underlying dynamics. We developed a new paradigm that separates underlying memory from the final memory decision, allowing these dynamics to be examined directly. In the present study, older and younger adults first searched for target objects in congruent or incongruent locations within scenes. In a subsequent test, participants indicated where in each scene the target had been located previously, and provided confidence-based recognition memory judgments that indexed underlying memory, in terms of recollection and familiarity, for the background scenes. We found that age-related increases in schema effects on spatial recall were predicted and statistically mediated by age-related increases in underlying memory failures, specifically within recollection. Moreover, we found that older adults had poorer spatial memory precision than younger adults within recollected (but not familiar) scenes, irrespective of schema congruency. Interestingly, there were also age-related increases in schema effects on spatial recall above and beyond what could be explained by memory failure or reduced memory precision alone. Together, these findings support the account that age-related schema effects on memory are driven by underlying memory failures, and they also suggest that there may be active schema influences on memory occurring alongside these compensatory effects.