What Is a Short Refinance?
Short refinance is a financial term that refers to the refinancing of a mortgage by a lender for a borrower currently in default on their mortgage payments. Lenders short refinance a mortgage in order to help a borrower avoid foreclosure. Typically, the new loan amount is less than the existing outstanding loan amount, and the lender sometimes forgives the difference. Though the payment on the new loan will be lower, a lender sometimes short refinances because it is more cost effective than foreclosure proceedings.
How a Short Refinance Works
When a borrower cannot pay their mortgage, a lender may be forced to foreclose on the home. A mortgage, one of the most common debt instruments, is a loan—secured by the collateral of specified real estate property—that the borrower is obliged to pay back with a predetermined set of payments. Mortgages are used by individuals and businesses to make large real estate purchases without paying the entire value of the purchase up front. Over a period of many years, the borrower repays the loan, plus interest, until they eventually own the property free and clear.
If the borrower cannot make payments on their mortgage, the loan goes into default. Once the loan is in default, the bank has a few options. 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.
- A lender may prefer to offer a short refinance to a borrower instead of going through a lengthy, expensive foreclosure.
- A short refinance can ding a borrower's credit—but so can late and/or missed mortgage payments.
- Lenders may consider a forbearance agreement or a deed in lieu of foreclosure, which both may be more cost effective than foreclosure.
But foreclosure is a long and expensive legal process, which a lender might want to avoid because it may not receive any payments for up to a year after beginning the foreclosure process and it may lose out on fees associated with the procedure.
Short refinance is a financing solution some lenders choose to offer a borrower who is at risk of foreclosure. A borrower may also ask for a short refinance. There are advantages for the borrower: A short refinance allows them to keep the home and reduce the amount they owe on the property. But that also represents an inherent disadvantage, since a borrower's credit score is likely to drop because they're not paying the full amount of the original mortgage.
Example of a Short Refinance
Let's say that the market value of your home dropped from $200,000 to $150,000 and you still owe $180,000 on the property. In a short refinance, the lender would allow you to take out a new loan for $150,000, and you wouldn't have to pay back the $30,000 difference. Not only would you have a lower principal, but in all likelihood, your monthly payments would be lower too, which could help you better afford them.
A short refinance has two advantages for a borrower: It allows them to keep their home and it lowers the amount they owe on the property.
Short Refinance vs. Forbearance Agreement
A short refinance is just one of several alternatives to foreclosure that might be more cost effective for the lender. Another potential solution is to enter into a forbearance agreement, a temporary postponement of mortgage payments. The terms of a forbearance agreement are negotiated between the borrower and lender. Or, a lender may opt for a deed in lieu of foreclosure, which requires the borrower to deed the collateral property back to the lender—in essence, giving up the property—in exchange for release from the obligation of paying the mortgage.