Will a Short Refinance Payoff Hurt My Credit Score?

Twenty-five percent of mortgage holders owe more than the current market value of their home -- they have what's called an underwater mortgage. Many people in this situation seriously consider just walking away from an underwater mortgage, but you should consider another option: short refinance. This can save your home, but sacrifices your credit score.

How it Works

In a short refinance deal, the mortgage provider forgives the "underwater" portion of the mortgage and writes a new loan. If you have a $200,000 home worth $170,000, the lender would forgive $30,000 and authorize a $170,000 loan. The lender typically reports to the credit agency that the original mortgage was "settled" -- a negative item than drops a good credit score anywhere from 45 to 125 points, according to Bank Rate.

Is It Worth It?

Whether you should go for a short refinance depends on the status of your mortgage. If you are current on your payment, you might be able to save tens of thousands on your mortgage in return for a negative item that will disappear from your credit history in seven years. If you are behind on your payments, you probably already have a rocky credit history and would likely see a much a smaller dip in your score, because negative items affect you less as your score goes down. This may, then, be a small price to pay to keep your home and avoid a bigger negative item: foreclosure.

Considerations

A short refinance could have effects on your credit other than a "settlement." Lenders usually require the borrower to fall behind on his payments by several months before approving any type of settlement. Purposely missing payments hurts your score by 70 to 135 points, according to CNN. Any future late payments or negative items look even worse in light of the previous late payments and settled account.

Alternative

Getting a lender to approve a short refinance is difficult and most people who default on their mortgage end up in foreclosure. This occurs because you must prove a hardship case and that the short refinance will cost less than a foreclosure. An alternative to this is a deed in lieu of foreclosure -- where you give the bank your home and it cancels the loan. A "deed in lieu" hurts your credit score, but you get out of the mortgage without owing anything further.