The softer economy more and more often makes foreclosures a hard fact of life -- an economy where "short sales" can become a possible way out for some borrowers -- albeit a questionable one.

A short sale occurs when a lender agrees to write off the portion of a mortgage that's higher than the value of a home -- provided there is a buyer willing to purchase the property.

As the last recession gathered steam during the early-1990s some financially strapped homeowners turned to the short-sale bail-out option to unload homes and mortgages they could no longer afford.

The technique can offer a softer landing than bankruptcies or foreclosures, but many homeowners may not survive the turbulence on the way down.

With lay-offs, e-commerce failures, smaller profits, and no profits in the news each day, market conditions are once again setting the stage for this old option.

Growing Delinquencies

Mortgage Information Corp. says 0.16 percent of borrowers in the year 2000 have fallen seriously delinquent -- 90 days late -- on their mortgage payment. That is more than twice the rate of delinquencies from 1999, 0.07 percent, and three times as high as the 1998 rate, 0.05 percent.

The San Francisco-based home loan repayment monitoring organization analyzes 75 percent of all outstanding home mortgages and blames the softer economy, larger loans and low down payments for the higher number of delinquencies.

Layoffs from the softer economy are swelling the ranks of the unemployed at a time when workers can least afford to be jobless. Mortgage debts are larger than ever.

On the average, compared to previous years, more than twice as many home owners have larger mortgage debts ranging from $250,000 to $1 million, Mortgage Information reported.

Low down payments have always been associated with higher delinquency and foreclosure rates. It's why lenders tack on private mortgage insurance (PMI) for purchases with less than 20 percent down. Those with the smallest equity stakes may feel they have little to lose and walk away from the American Dream.

Mortgage Information said 41 percent of borrowers in the year 2000 had less than 20 percent down on their home purchase.

What's more, new borrowers from 2000 who took out "subprime" mortgages -- high-rate home loans designed for buyers with imperfect credit histories -- are performing even worse.

Overall loan delinquencies on subprime mortgages are up 21 percent and that's substantially higher than subprime delinquency rates in the previous three years, Mortgage Information said.

Easy Come, Easy Go

During the late 1990s increasingly easier loan qualifying rules have allowed more and more borrowers to land mortgages and pile on equity debt -- often for all the wrong reasons.

Borrowers who refinanced home mortgages during recent refinancing booms piled on home-secured debt, raising their first mortgage loan-to-value (LTV) ratio by an average of 6 percent, their first mortgage balance by $41,000, and their interest rate an average of 0.60 percent, according to the MGIC Capital Markets Group, a private mortgage insurance provider.

Half of home owners who refinanced did it to pay off consumer debt -- credit cards, car loans and other debts -- not to lower their interest rate or shorten their loan term said MGIC.

That's a big jump from the refinancing booms of 1992-93 and 1998-99, when only 20 percent of borrowers refinanced to pay off consumer debt, according to MGIC.

Finally, adding to the delinquency toll are so-called "predatory" mortgages -- high-rate loans with tough terms aimed at vulnerable, credit-poor borrowers who often initially can't afford to pay for the loan they get.

Short Sale Caveats

It all adds up to a convergence of conditions similar to those during the previous economic downturn when short sales were used and abused.

Then short sales were born of the real estate bust which followed a boom of inflated home prices. Home owners who purchased or refinanced a home just as the market peaked ended up with mortgage balances that were substantially larger than the value of their home -- so called "upside down" loans.

Right now, some Northern California home owners are beginning to experience that all too familiar stomach wrenching financial flip flop.

Financially troubled home owners consider short sales largely because credit-report information generated by a short sale is generally less damaging than bankruptcy, a judgment or other lien action.

The short sale, however, is not a panacea.

Short sales are perhaps the most difficult consumer real estate transaction to approve, involving as much, if not more paperwork than an original mortgage application.

Instead of proving your credit worthiness and financial stability, you must prove you are broke. You must be without cash flow, including savings, investments, trusts, liquid retirement funds or other finances to tap.

Ironically, while you are proving insolvency you may reveal the dark side of your original application. Insolvency today could be rooted in financial trouble that began before you purchased your home -- trouble you didn't reveal to your lender who might now consider your tight lip behavior fraud.

Property encumbered by a second mortgage will likely kill a short sale deal, because the second lender often won't remove its lien and risk losing its investment. A private mortgage insurance holder will also want to protect its interests.

Before you can even approach the lender you must have a firm market-value offer from a qualified buyer and a broker who can negotiate the deal.

And when you can least afford it, you may have to hire an attorney to negotiate what the lender will report to the credit agency.

If you qualify for the short sale, it isn't over when you sign the final papers to back you out of your mortgage.

Any remaining difference between your home's value and the balance on your mortgage is considered a forgiveness of debt and, in virtually all cases, that's taxable income. For specifics, speak with a CPA, tax attorney, or enrolled agent before entering into a short-sale agreement.

Be aware. Be very aware of the devil in the details of a short sale.

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