A Guide to Short Refinancing

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Credible Operations, Inc. NMLS # 1681276, is referred to here as “Credible.”

A short refinance replaces your existing mortgage with a new mortgage that has a lower balance when you’re at risk of foreclosure. You can only do this type of refinance if your loan servicer is willing to write off a portion of what you owe.

If you’re underwater on your mortgage and you can’t do a regular refinance or sell your home, a short refinance could be a solution.

Here’s what you need to know about short refinances:

What is a short refinance?

A short refinance, or short payoff, is a type of rate and term refinance that might help you if you owe more than your home is worth, you’re in danger of falling behind on your mortgage payments, and you want to keep your home. In other words, you don’t want to consider a short sale or find yourself in foreclosure.

What is a short sale? A short sale is when you sell a home for less than the current mortgage balance. This can help you avoid foreclosure. Your mortgage lender must approve a short sale before you can move forward with one.

This type of refinance was more well known in 2010, when, in the wake of the 2008 housing crisis, the Obama administration introduced the FHA short refinance program to help underwater homeowners (those with homes worth less than their current mortgage balance) stay in their homes. The federal government allocated $45 million to this program to encourage lenders to participate by mitigating their potential losses.

The FHA short refinance program ended in 2016. It was small; far more homeowners got assistance through the $22 billion Making Home Affordable program.

Short refinancing isn’t popular today, because home values have gone up substantially nationwide, interest rates (including refinance rates) have been below 6% for more than a decade, and COVID-19 relief programs have helped homeowners harmed by the pandemic to stay in good standing with their lenders.

While Credible doesn’t offer a short refinance option, we can help you easily compare the latest mortgage refinance rates.

How a short refinance works

Short refinancing is unlikely to make a comeback anytime soon. While some housing markets may be overvalued, experts say sharp declines in home prices aren’t likely because of the ongoing nationwide housing shortage.

But when a short refinance does happen, here’s how it works.

Short refinance example

Let’s say you purchased your home for $300,000. You put down the minimum: 3%, or $9,000. You borrowed $291,000.

You got a 30-year fixed-rate mortgage with an interest rate of 5%. You’re now five years into your loan, and your principal balance is $266,773.

Unfortunately, your home is now only worth $250,000, and you can’t keep up with your $1,562 mortgage payment, plus property taxes and insurance. A major employer left the area, and hundreds of people had to move to get new jobs, depressing the housing market. It took you several months to find a job, while living expenses decimated your emergency savings.

Fortunately, you’re working again. Unfortunately, your income is a bit lower and your mortgage payment is now unaffordable. You reach out to your loan servicer and explain your situation.

Having already lost money on numerous foreclosures in the area, your loan servicer is willing to do a short refinance. They’ll give you a new loan for $250,000 and write off the $16,773 that you owe. Your new loan will have the same interest rate (5%) and term (30 years), lowering your payment by $220 a month to $1,342.

Also See: How to Lower Your Monthly Mortgage Payment

Short refinance tax implications

The IRS, unfortunately, considers canceled debt to be income. That means you’ll need to be prepared to pay income tax on the $16,773 come April. Even with the time you weren’t working, your marginal tax rate looks like it’ll be 22% this year. Now you need a plan to pay an additional $3,690 in taxes.

How can you possibly save up that money by April? You probably can’t. You’ll have to work out a payment plan with the IRS — but you’ll get to keep your house.

It’s not a great situation to be in. Short refinancing was more favorable to homeowners before 2018, when the Mortgage Forgiveness Debt Relief Act of 2007 expired. From 2007 to 2017, homeowners typically didn’t have to pay tax on forgiven mortgage debt.

Short refinance pros

A short refinance, if available, could help you:

• Avoid foreclosure. Foreclosure means you lose your house. Your lender becomes the home’s new owner and sells it to pay off your loan balance, plus all the late fees and legal fees you’ll accumulate during the foreclosure process. Foreclosure can tank your credit score and will keep you from getting another mortgage anytime soon.
• Avoid a short sale. Think of a short sale as a voluntary foreclosure that requires your loan servicer’s permission. Your servicer may agree to let you sell the home for less than you owe if it’ll be less costly for the servicer than foreclosing. A short sale will also hurt your credit score and make future borrowing more difficult.
• Get a fresh start. A short refinance can give you a new monthly mortgage payment that you can afford in your changed circumstances. If you can keep up with that payment, as well as your property taxes and insurance, you’ll get to keep your home.

Short refinance cons

A short refinance also has several significant drawbacks:

• It’s hard to find. The most common solution loan servicers offer to borrowers struggling to pay their mortgage is a loan modification. A loan modification can help you stay in your home, too, but it’s more appealing to your loan servicer because they don’t have to write off part of what you owe. Instead, your servicer might extend your loan term to reduce your monthly payments, which means you’ll still pay everything you agreed to, but with additional interest.
• It may hurt your credit score. When a lender writes off debt you owe and reports it to a credit bureau, it’s almost certain to hurt your credit score. Of course, foreclosures and short sales aren’t good for your credit score, either.
• It’s taxable. The IRS looks at canceled debt as income. Unless your income is so low that the standard deduction cancels it out and puts you in the 0% tax bracket, you’ll probably owe tax of at least 10% (the next-lowest marginal tax rate) of whatever amount the lender forgives.

If you’re struggling with your monthly payments but can still afford to do a traditional refinance, Credible can help. Credible makes refinancing easy. You can compare personalized refinance rates from all our partner lenders in the table below — checking rates with us is free and won’t affect your credit.

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