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Age-related declines in episodic memory do not affect all types of mnemonic information equally: 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 this effect: One proposes that schemas compensate for memory failures in aging, and the other proposes that schemas instead actively impair older adults’ otherwise intact 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 paradigm that separately examines the contributions of underlying memory and schema knowledge to a final memory decision, allowing these dynamics to be examined directly. In the present study, healthy 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 target location spatial recall were predicted and statistically mediated by age-related increases in underlying memory failures, specifically within recollection. We also found that, relative to younger adults, older adults had poorer spatial memory precision within recollected scenes but slightly better precision within familiar scenes—and age increases in schema bias were primarily exhibited within recollected scenes. Interestingly, however, there were also slight age-related increases in schema effects that could not be explained by memory deficits alone, outlining a role for active schema influences as well. Together, these findings support the account that age-related schema effects on memory are compensatory in that they are driven primarily by underlying memory failures, and further suggest that age-related deficits in memory precision may also drive schema effects.