So you've come to the conclusion that you can't afford your mortgage and you've had no luck trying to work out a refinance or a loan modification. Is there anything you can do other than sit around and await the inevitable?

Actually, there is - a short sale. In a short sale, your lender agrees to allow you to sell your home for less than the balance owed as an alternative to foreclosure. For banks, it's an attractive alternative to the expense of foreclosing and selling the property on your own. For the homeowner, it enables them to get out of their mortgage with less damage to their credit rating than a foreclosure or bankruptcy would cause.

Short sales have become an increasingly popular alternative to foreclosure in the current economic climate. Bank of America reports that is has seen a 50 percent increase in short sales it has approved this year. Many banks are also taking steps to streamline the process, shortening what can be a months-long wait for approval to a matter of weeks.

Incentives available for homeowners, lenders

The Obama Administration has also taken steps to promote short sales, offering incentives for both lenders and homeowners. Lenders can now receive up to $1,000 for each short sale concluded, while homeowners may be able to receive up to $1,500 in moving and relocation alternatives under the Foreclosure Alternatives initiative under the Making Home Affordable Program.

A few things to understand first. To do a short sale, you need to be underwater on your mortgage, that is, owe more than the property is worth. If you don't, it's not a short sale, you're simply selling the property at a loss.

Second, before resorting to a short sale, you need to try other alternatives first, such as working out a loan modification or a refinance. You can contact your lender about these options or, better yet, speak with a HUD-certified housing counselor in your area, who can help evaluate your options and advise you on the short-sale process if that seems like the best choice in your situation.

Short sale process can be lengthy

Short sales also take time. Although banks are trying to streamline the process, historically they take several months. So if you recognize that you're not going to be able to afford your mortgage, you need to start preparing now if you want to either complete a loan modification or short sale before the foreclosure process runs its course.

Also, you have to recognize that you're not going to be able to do a short sale if you're too far underwater on your mortgage. Many lenders are willing to take a 10 percent markdown on a short sale - but will probably balk at 20 or 30 percent, although the current economic downturn may make them more flexible than usual.

While you don't have to be delinquent on your loan, you do have to be in real financial difficulty. Your lender's not going to agree to take a loss through a short sale if you're sitting on $20,000 in CDs, stocks or a savings account. You're going to need to detail your financial hardships in a letter. Also, it's a good idea to curb your spending while applying - your lender won't be favorably impressed to see that your credit card records show you've been dining out four nights a week while pleading financial distress.

Experienced realtor an asset

To do a short sale, you're going to want a realtor who's had some experience in doing them. Short sales can be complex, with a lot of players involved - including the bank, the buyer, the second lien holder, etc. - so you want someone who understands the process. Also, you want to make sure you're dealing with an experienced rather than an aspiring short sale realtor - with short sales becoming more popular, many realtors are trying to get in on the game, and may advertise themselves as doing short sales without actually having completed one yet.

The next thing you need to do is find a buyer, which the realtor will help you do. The buyer needs to be someone who's 1) looking for a bargain and 2) is willing to wait out the sometimes drawn-out process of getting a short sale approved. In fact, most short sales eventually fall through, usually because the buyer gets tired of waiting. This is where it will help if your loan is through a bank that's been trying to streamline its short sale approval process.

Your realtor will suggest a price that hopefully will be attractive enough that the buyer will be willing to wait out the process and that the lender will accept it fairly quickly, before the buyer gives up and looks elsewhere. For your part, the price really doesn't matter - you're just trying to get out the mortgage, and the eventual sales price isn't going to benefit or hurt you one bit. All that matters is that the property is sold.

Prepare like for any sale

That said, you're still trying to sell the property. So you need to do all those other things you normally would do to make it appealing and help it sell in any other situation. Clean out the garage and basement, mow the lawn, maybe touch up a bit of paint here and there - how much effort you put in depends on how much you want to minimize damage to your credit. You're also going to have to deal with open houses.

If your short sale is approved, the sale will go on your credit report as a debt settlement. Be aware, too, that the IRS may treat your forgiven debt as income for tax purposes. Short sales of primary residence are exempt from that rule, at least through 2012, although debt forgiven on vacation homes and investment properties is still subject to the tax.

Having to give up your house is never easy. But if you prepare for it properly, a short sale can at least be one of the less painful ways of going about it.

Published on February 20, 2007