How to do a short sale

Red home for sale sign on lawn

You're struggling to make your mortgage payments. Your home is worth less than you owe, and your finances are so shaky your lender won't modify your loan.

Before you resign yourself to foreclosure, see whether a short sale can get you out of trouble.

With a short sale, you accept an offer on your home that's less than what you owe on your mortgage and your lender forgives the remaining debt -- the difference between your mortgage balance and the net proceeds from the sale.

You leave with no outstanding debt and less damage to your credit history than a foreclosure. You can qualify for an FHA-backed loan three years after a short sale if you were in default at the time of the sale.

Don't kid yourself. Short sales are usually a long and arduous process.

Lenders and mortgage servicing companies can take months to review a short sale, and won't approve any deal unless it's less costly than going through with a foreclosure.

All of the complications and delays often cause buyers to throw up their hands and walk away. Deals can be squelched by a second or third lien holder (such as a home equity loan lender) over a few thousand dollars.

Here are the 7 steps to completing a short sale deal:

Step 1. Find out if your lender or mortgage service company will consider a short sale and what you'll need to provide.

Call the loss mitigation department and ask a supervisor whether a short sale is possible. Some investors that own large numbers of mortgages won't accept such a loss, so if the answer is "no," the process ends right there.

You can't do a short sale without the lender's approval.

If a short sale is possible, ask what documentation you'll need to seek approval. The typical "short sale documentation package" requires:

Step 2. Hire a real estate agent who's experienced in short sales.

Interview several agents and ask how many short sales they've closed in the last 12 months and whether they've received any special training in short sales. Get references from their short sales clients.

When you pick one, give the agent power of attorney so he or she can talk directly to your lender. You need a well-versed agent who knows how to work with a loss mitigation department and move your deal along.

Step 3. Find the right price.

You won't get any offers if the price is too high. But your lender may not accept a short sale if the price is too low.

According to Tim Harris, cofounder of Harris Real Estate University in Las Vegas, lenders usually go for a short sale that nets at least 82% (after expenses) of the home's fair market value.

A Realtor experienced in short sales makes sure that the broker checks the house inside and out and gives the broker comparable listings and other info to help the broker price the house accurately and quickly.

Step 4. Put your home up for sale and start preparing your short sale documents.

Think of a short sale documentation package as a mirror image of a loan application. You want to make your finances to look as bad as possible without lying.

Lenders are most likely to consider short sales when a homeowner has serious financial problems, so the hardship letter is the cornerstone of your case.

Like a good country song, your hardship letter tells a heart-rending tale of how you got into this mess -- for example, you've plundered your savings to pay your spouse's medical bills and you can't afford your mortgage payment now that you're living on one small income.

Step 5. Cut a deal with lenders that have second mortgages on your home.

If you have a home equity loan or line of credit from a bank or mortgage company that's not your primary lender, it must lift its lien on the home even though it won't get a cent from your deal.

"Most second lien holders go along with short sales because they get nothing from a foreclosure," says Paul Hickman, president of California Land Title of Marin.

That means they've accepted your loan as a total loss, no matter what.

"But some stop deals cold because of $10,000 owed to them," Hickman says.

If you run into a recalcitrant second mortgage holder, suggest a "short pay," which means you agree to repay some of what you owe as an unsecured personal loan.

Another option is to ask whether the second mortgage holder will accept a few thousand dollars from the primary lender in exchange for lifting the lien.

Most will, although a few are demanding up to 5% of the sale's proceeds.

Just cut the best deal you can and hope your primary lender will accept it.

Some will.

Step 6. Pick a good buyer.

If you've priced the home right, you may get several bids.

If that's the case, you want to pick the best possible buyer. That means someone with a substantial down payment, preapproved mortgage and few contingencies (such as having to sell their current home before buying yours).

The stronger the buyer, the more likely you are to win approval from your lender.

Step 7. Submit the deal for approval.

Loss mitigation departments are overwhelmed by foreclosure proceedings, loan modification requests and, of course, proposed short sales.

It's critical that you submit all of the documents your lender requires and follow its guidelines to the letter.

If you don't, your deal can be delayed, sometimes for months. And don't expect the lender to tell you that something is missing. You have to follow up to make sure you've provided everything the lender needs.

If all goes well, your lender will approve your short sale in three to six weeks, and your deal will close in about two months.