Short-refi: The ins and outs

06.05.09
By John Ulzheimer

In today's horrific mortgage environment, nothing spells relief faster than your current lender allowing you to reduce the principle amount of your loan in order to make it more affordable. This can be accomplished one of two ways: a traditional loan refinancing or the short-refinance. So what is a short refinance and how does it work?

A short refinance, or short-refi for short (pardon the pun), works just like any other refinancing of your mortgage loan. Your lender allows you to take out a new loan to replace the existing loan but with new terms. The loan can be with your current lender or with a new lender. After a traditional closing, which involves you signing many documents, you walk out of the closing attorney’s office with the same house and a new payment.  

The primary difference is that instead of you owing the same loan amount as before, now you owe much less. So how in the world did this happen? Simple: Your lender has given up a portion of the principle amount. They’ve essentially allowed for a short sale of your home, back to yourself.  

The short-refi has upside. You’re in the same house but now you owe less for it. Perhaps you even owe an amount equal to its new current value. The point is that you’re still in your home and now you have an affordable payment, which means you’ll stay in your house. You’ll continue to take care of it and its value will eventually turn in your favor. This is good for you and good for your neighborhood.  

The short-refi also has downside, which you should understand if you choose to pursue this option. The short-refi is essentially a settlement by the lender. They are accepting a payment in full (the new loan) to pay off the mortgage (the existing loan). They have chosen to charge off what’s referred to as the deficiency balance. And they will likely report this to the credit reporting agencies.  

The charge-off will remain on your credit reports for seven years and will be considered negative not only by lenders but will also damage your credit scores. It will make it difficult for you to get favorable rates on new loans for some time. But this scenario may be a small price to pay for the privilege of staying in your home.

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The short-refi is essentially a settlement by the lender.