In today's real estate market, many people find themselves squeezed by variable rate mortgages resetting, or otherwise unable to keep up with their house payments due to illness, divorce, death of a partner, or other personal tragedy. If they have substantial equity in their property, and enough time, they may be able to sell their house through a real estate agent to a conventional buyer. But, in many cases, there will not be enough equity in the property to pay real estate agent commissions, closing costs and the lender's payoff figure. If the home-owner is in default, you can add substantial penalties and attorney's fees to the list.

So what can someone facing that dilemma do? Often they have been advised to file bankruptcy, and told that this will stop a foreclosure. And while it will certainly do that, it is a temporary measure: it will only delay the process. After about 60 days, the lender will probably apply to have the property removed from the protection of the bankruptcy, and will proceed with the foreclosure. If there is little or no equity in the property, the request is likely to be granted.

Obviously, one option is just to let the property go to foreclosure, with all the personal credit consequences that entails. An alternative that is gaining more acceptance these days is to do what is called a "short sale". That is where the lender accepts an amount less than the total owed on the mortgage, in settlement of the indebtedness. This saves them both the hassle and the costs involved in the foreclosure process, such as attorney's fees, real estate brokers' appraisal costs, auction costs, insurance, repairs, routine maintenance charges, and carrying costs.

It also avoids the lender facing the prospect of having to take the property back after it fails to sell at an auction. If that happens, the lending institution has all of the costs mentioned above, plus a very significant addition - they have to maintain financial reserves equal to 6 or 7 times the value of the property they hold. It is this requirement that has caused so many banks to fail in the past. If they can avoid this situation, they would like to do so.

Before initiating the short sale process, the lender usually requires that the borrower is already in default, but increasingly, lenders are now working with people who are not behind in their payments, but are certainly going to be in the near future. This is sometimes called "Easy Mitigation".

For a lender to consider a short sale, they need to see a certain amount of information. Basically, just as the borrower had to prove they could afford the loan in the first place, now they have to prove they can't! So the information that has to be provided is very similar, including: bank statements, financial records, details of the property value, values of comparable properties, and very importantly a "hardship letter" explaining how this situation came about.

There is no guarantee that a lender will agree to a short sale, but they are much more likely to be sympathetic if an unpredictable event occurred and resulted in genuine financial hardship, than if the borrower repeatedly stripped the equity out of the property and now wants to avoid the financial consequences of that. Nevertheless, whatever the circumstances, it is worth trying to negotiate a short sale rather than face a foreclosure. While a short sale will still have an impact on the individual's credit score, it is less damaging than a full foreclosure would be.

In order to approach the lender with a request for a short sale, the home-owner must have an offer from a buyer, and that buyer must be unrelated to the seller. One of the absolute rules of a short sale is that the borrower cannot receive any money from the proceeds of the sale, and that includes any member of the family benefiting.

In summary, there is no perfect solution for someone facing potential foreclosure but, if the borrower acts in time (short sales can take 45 to 60 days to negotiate) there are alternatives that are less damaging and that can leave them better placed to rent or buy again in the future. It is also important to use someone familiar with the short sale process to negotiate with the lender - this is not a time for someone to learn the process at the borrower's risk!

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