What Is a Short Refinance?
A short refinance occurs when a mortgage lender refinances a mortgage loan for an amount that's less than the borrower owes. A lender might agree to a short refinance if the borrower's current mortgage is in default or in danger of it. Here is how it works.
Key Takeaways
- A short refinance is when a mortgage lender refinances a mortgage loan for an amount less than the borrower owes.
- A lender may prefer to offer a short refinance to a borrower instead of going through a lengthy, expensive foreclosure process.
- A short refinance can hurt a borrower's credit score, and there are also tax implications.
- Instead of a short refinance, lenders may also consider a forbearance agreement or a deed in lieu of foreclosure, as both may be more cost-effective.
How a Short Refinance Works
In a short refinance, the lender issues a new loan and forgives the difference between what the borrower owes and the new loan amount.
Mortgage lenders may be willing to offer to a short refinance to help a borrower avoid foreclosure, because doing so can be more time- and cost-effective for the lender than going through foreclosure proceedings.
Foreclosure is the process through which a lender takes possession of a home or other asset that the borrower pledged as collateral in order to obtain the loan. With home mortgages, the home itself usually serves as collateral.
If a borrower cannot make payments on their mortgage, the loan goes into default, and the lender has the right to foreclose on the home. Foreclosure is the most widely known (and feared) of the lender's options, as it means the lender takes control of the property, evicts the homeowner, and sells the home.
However, foreclosure is a long and expensive legal process that a lender might want to avoid. The lender may not receive any income from the property for up to a year after beginning the foreclosure process, while having to pay to maintain it, insure it, and cover any tax bills in the meantime. In addition, there is no guarantee that the sale of the home from the foreclosure will be enough to repay the outstanding mortgage debt, particularly if the market value of the home has decreased.
Lenders are under no obligation to do a short refinance, and many will not.
Advantages of a Short Refinance for Borrowers
As mentioned, a short refinance has obvious advantages for the lender, but the borrower may also benefit. The new loan will be more affordable, and as long as the borrower keeps up with the payments they will be able to remain in their home.
Disadvantages of a Short Refinance for Borrowers
There are also some downsides to a short refinancing from a borrower's perspective. The borrower's credit score may decline, although not as much as it would as the result of a foreclosure. In addition, the Internal Revenue Service treats canceled or forgiven debt as income, so the borrower will have to report it and may owe taxes on it. However that may be a small price to pay for not losing the home.
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 with the Consumer Financial Protection Bureau or the U.S. Department of Housing and Urban Development (HUD).
Short Refinance vs. Other Foreclosure Options
A short refinance is just one of several alternatives to foreclosure that might be more cost-effective for a lender. Another potential solution is to enter into a forbearance agreement, a temporary postponement of mortgage payments, which could allow the borrower time to get back on their financial feet. The terms of a forbearance agreement are negotiated between the borrower and the lender.
A lender could also opt for a deed in lieu of foreclosure, which requires the borrower to deed the property back to the lender—in essence, giving up the property—in exchange for release from the obligation of paying the mortgage.
Example of a Short Refinance
Let's say that you are in danger of defaulting on your mortgage, and you call your lender to find out what options you might have. Your lender suggests a short refinance.
It turns out that your home's market value has decreased from $200,000 to $150,000. However, you still owe $180,000 on the property. With the short refinance, the lender would allow you to take out a new loan for the current value of $150,000. At the same time, the lender would forgive the $30,000 difference between the original mortgage loan and the new loan amount ($180,000 - $150,000).
Your new loan would have a lower principal, and also, in all likelihood, lower monthly payments. As a result, you'd be better able to afford the payments, avoid foreclosure, and remain in your home.
Can You Refinance a Mortgage Iif You Are in Default?
Yes, you might be able to refinance a mortgage that's in default. However, it's important to call your lender or mortgage servicer (the company that receives your payments) to inform them that you're struggling to make the payments. You can also get help by calling a mortgage counselor approved by the Department of Housing and Urban Development (HUD).
How Many Months of Payments Can I Miss Before Foreclosure?
Typically, three to six months of nonpayment may start the foreclosure process on a mortgage. You'll also be charged late fees after 10 to 15 days of being late with your payments.
What Are the Advantages and Disadvantages of a Short Refinance?
The advantage to lenders of a short refinance is that they may earn more money from the new, reduced loan amount than they would from selling the house in a foreclosure. The advantages for the borrower include a lower loan amount, lower monthly payments, and the ability to remain in the home.
The Bottom Line
A short refinance can help a homeowner who's struggling to make their mortgage payments or who is already in default. The short refinance involves the mortgage lender refinancing the loan for an amount less than the borrower originally owed.
A lender may offer a short refinance to a borrower because it avoids the lengthy, costly process of foreclosure. A short refinance can help the borrower since it will lower the loan amount and monthly payment, as well as help them stay in their home. However, a short refinance can damage a borrower's credit score, making it more difficult to get approved for new credit in the future.
