What Is a Short Refinance?

A short refinance is a mortgage refinancing solution designed to help borrowers struggling with mortgage payments. If you want to remain in your home and avoid foreclosure, a short refinance can be a lifeline. It's especially valuable to borrowers if their homes have dropped in market value. Read on to understand how a short refinance works and weigh the additional financial implications. 

What Is a Short Refinance?

A short refinance is a mortgage refinance option offered by some lenders. It is specifically for borrowers struggling to make their monthly mortgage payments. It can help borrowers who have negative equity in their home or are struggling to pay the mortgage each month to secure a lower mortgage amount and payment requirements. 

How Does a Short Refinance Work?

A short refinance occurs when a mortgage lender refinances a mortgage for less than the borrower owes. The lender might opt for a short refinance if you are behind on mortgage payments and risk foreclosure. 

A short refinance can hurt your credit score, and there can also be 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.

With home mortgages, the home itself usually serves as collateral. If a borrower fails to pay, a lender could repossess the property and sell it to recoup its costs. This process is called foreclosure. But it's not ideal for either the lender or the borrower.

A lender might be willing to offer a short refinance to avoid the lengthy and costly process of foreclosure. This is a win for both the borrower and the lender. The lender gets payments, even while forgiving some portion of the loan. 

Example of a Short Refinance

Suppose you have a mortgage with an outstanding principal balance of $250,000. Your monthly mortgage payments are $1,500, and the loan term has 20 years remaining. If you've been late on payments or missed multiple payments, the lender may be concerned about foreclosure. 

If, in addition, your home's market value has decreased from $270,000 to $230,000, the lender might allow you to take out a new loan for the current value of $230,000 and forgive the $20,000 difference between the original mortgage and the new loan amount ($250,000 — $230,000).

In that case, they may agree to a short refinance for $230,000, with a loan term of 30 years, lowering your monthly payments and the total owed. 

Pros and Cons of a Short Refinance

There are pros and cons to a short refinance for borrowers. Here's what you'll want to consider. 

Pros

• Get a manageable monthly payment: With the short refinance, you could lengthen the term or reduce the monthly costs, making payments easier to fit into your budget.
• Lower loan balance: If part of your mortgage is forgiven, the remaining balance may be more manageable, 
• Avoid foreclosure: Most fundamentally, a short refinance can help you avoid losing your home. 

Cons

• Credit score: A short refinance typically dips your credit score, although not as much as a foreclosure. 
• Tax costs: Any forgiven debt is considered income, and you must pay the relevant income tax. 
• Not a total solution: If you're struggling to make mortgage payments, a reduced monthly payment may not be low enough to make it manageable. 

What Are the Tax Implications of a Short Refinance?

The Internal Revenue Service views canceled or forgiven debt as income. That means you must report the full amount and may owe taxes. However, this is typically more manageable than losing your home. You can learn more from the IRS policy on canceled debt.

Other Alternatives to a Short Refinance

Here are some common alternatives to a short refinance you can consider:

Rate-and-Term Refinance

A rate-and-term refinance allows you to replace your mortgage loan with a new loan with a different interest rate or term without advancing additional cash. You might choose a rate-and-term refinance if mortgage interest rates have decreased or if you could secure a lower interest rate.

Forbearance Agreement

A forbearance agreement is negotiated directly with the lender. This temporary postponement of mortgage payments could give you time to get back on your feet and start making mortgage payments. 

Deed in Lieu of Foreclosure

A deed in lieu of foreclosure is another alternative that requires you to give up the property with a deed back to the lender. In exchange for the deed in lieu of foreclosure, you'll be released from the obligation of paying the mortgage. However, you'll lose the property, so a short refinance could be a better option. 

Loan Modification

A loan modification is typically granted to a borrower in a financial crisis. The lender makes these modifications, which could include a reduction in the interest rate, an extended repayment term, or a different type of loan. To get a loan modification, you may need a legal representative or access to a government program that supports mortgage holders. 

Short Sale

You can consider a short sale as an alternative to a short refinance. In that case, you can sell the home for less than the mortgage is owed. The lender will collect the proceeds from the sale and then forgive the difference. In some cases, they will get a deficiency judgment requiring you to pay the leftover amount.

Compare the Best Mortgage Refinance Lenders From Benzinga’s Providers

Considering another type of refinance? You can find some of the best offers from Benzinga's trusted providers here:

Should You Choose a Short Refinance?

A short refinance could hurt your credit score and have possible tax implications, but it is still a better alternative than foreclosure. It can protect your property, reduce the loan amount, and get a more manageable monthly mortgage cost. 

If you're facing a short refinance, consider other refinance options, such as a cash-out refinance, a no-closing-cost refinance, an FHA Streamline Refinance, or a USDA streamline refinance. If you're over 65 and have significant equity in the property, you could also consider a reverse mortgage.

However, because of the average cost to refinance, these may (or may not) be an option. If you need to do a short refinance, carefully research costs and lender policies to understand the implications for your situation! You can use Benzinga's mortgage calculator, find more tips to shop for mortgages, and even learn how to lower your mortgage payment so you're ready to negotiate and get the best rates!

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