As a last ditch effort to avoid foreclosure and the ruining of their credit ratings, homeowners sometimes ask lenders for permission to do a "short sale." This transaction may be beneficial to you, but first weigh the pros and cons to be sure.

One way to salvage your credit when facing foreclosure is through a "short sale," which is a sale authorized by your lender that liquidates your property while erasing leftover outstanding mortgage debts. The short sale involves selling your house and giving the proceeds to the lender, even if the sales price is not enough to cover the full amount you owe on the mortgage. The lender forgives the rest of the balance owed, essentially wiping clean your debt.

Four important short sale tips

Consider the following before attempting a short sale:

1. You'll need to prove that you can't pay what's owed on your mortgage. Bring to the lender supporting documentation, such as a current appraisal of your property, a letter explaining your financial hardships, and recent comparable sales data for homes in your neighborhood. If you make a strong enough argument, the lender may agree to let you do a short sale, and then forgive the rest of your obligations.

2. You may still be subject to judgments and taxes. Even if you do a short sale, the lender may still sue you for outstanding balances owed, so try to negotiate the terms of debt forgiveness in writing with the help of a qualified real estate attorney. The IRS currently views forgiven debt as ordinary taxable income, so you'll be required to pay taxes on the amount of debt that the lender wipes off your account. That could add up to a substantial and unexpected expense at tax time.

3. Saving your credit score is worth it. Credit scores have far-reaching implications you may not even be aware of, because lots of people aside from bankers study them. More than 30 percent of employers check the credit results of applicants when reviewing new employee applications, according to the Society for Human Resource Management, and cell phone service providers often check credit before accepting new customers. Most of the major auto insurance companies also use credit scores to calculate rates, and may charge considerably more if you have bad credit.

4. Foreclosures are bad news for lenders. When a foreclosure happens, it's expensive not just for the homeowner, but also for the lender, who must step in and become a temporary landlord, property manager, and real estate marketer. Meanwhile, the money tied up in the home cannot be loaned to another bank or mortgage company customer. As a result, lenders are usually just as motivated as homeowners to avoid foreclosure.

Before attempting a short sale, examine all your other options. But if push comes to shove, the short sale may provide a shortcut to faster financial recovery by helping preserve some of your hard-earned and precious credit.

Published on February 14, 2008