What is a Short Sale? A short sale, defined as an "agreement" to allow a home to be sold for less than the amount that is owed, can be a helpful compromise for everyone involved. For debt-ridden homeowners or those who owe more than the house is currently worth, a short sale could save them some of the enormous pain, embarrassment, and major credit challenges associated with bankruptcy and/or foreclosure.

For lenders, it helps avoid some of the hassle and expense of seizing and auctioning off delinquent real estate. Lastly, for potential homebuyers and real estate investors, a short sale offers a great opportunity to purchase property at a significant discount in today's tight-fisted credit environment. And, while short sales are not by any means common or easy, inventory levels of unsold homes are now exceeding a 36-month supply in some parts of the country. Add to that the increasing number of foreclosures, and lenders are much more eager to negotiate with borrowers who are having trouble paying their mortgages.

Short Sale Requirements It's important to note that short sales occur at the sole discretion of the existing lender or servicing company. This is not like negotiating the price of a home under normal circumstances. Would-be buyers need to accept and understand this concept completely prior to entering into any purchase agreement on a short sale transaction. While a buyer and seller may come to some sort of agreement on their own, the lender in a short sale will ultimately have final approval of this legally-binding arrangement.

Remember, lenders are not looking to bail out borrowers who simply overextended themselves during the recent real estate boom. In most cases, a lender will only consider a short sale if a borrower has clearly suffered a serious financial hardship that directly caused him or her to default on the mortgage. This means the loss of a job, a serious illness, or the death of a loved one - something devastating and "unforeseen" that can justify such a state of financial disrepair. If you're a "flipper" with 2 or 3 homes that you weren't able to unload before the market turned, or if you have other assets or income that could easily cover your mortgage debt, it's not likely that a lender will accept a short sale proposal.

A written declaration and supporting documentation demonstrating financial hardship and an inability to make payments will definitely be required by the lender in order to even consider a short sale. This may include pay stubs, tax returns, and liquid asset statements - including those for retirement accounts - among other documentation. In addition, the borrower must be at least 91-days delinquent before a lender will even discuss a short sale.

In some cases, the lender's hands may be tied, depending on how the borrower's loan was sold into the open market through mortgage-backed securities. If the mortgage in question was not sold by the lender, but rather retained in its own portfolio, the lender may have more flexibility. However, don't expect a lot of help from the lender without first providing a sales contract from a qualified buyer and all the information required by the lender's loss mitigation department. This is where an experienced real estate professional becomes invaluable to your cause. A good real estate agent has not only successfully negotiated short sales in the past, he or she will also have access to qualified investors who are well-versed in the substantial risk and reward involved in this extremely complex and often drawn out process.

Important Additional Considerations:

• The lender will likely issue a 1099 to the seller for the difference between what is owed and the final amount the lender collects after the costs of the sale, including real estate commissions and possibly other charges. This means that the "deficiency" (the difference between the short sale price and the original loan amount) can be considered as taxable income to the borrower. Some lenders may even attempt to get the existing homeowner to sign a note for the remaining amount due.

• If there are currently multiple liens against the property, all lien holders will have to be involved in the negotiation process, not just the first lien holder. Therefore, communication and patience are essential components of any short sale.

• There is no guarantee of success. With several parties involved, it's difficult to please all sides all of the time. Short sales require expert advisors who know precisely what is to happen at every stage.

• A number of scams resembling short sales currently exist and, because of the obvious intensity of emotion involved with this process, borrowers can quickly become vulnerable to new scams.

In other words, be proactive. If you have an ARM that is scheduled to reset in the near future, or if you're facing foreclosure because of unexpected life events, don't wait until a short sale is your last viable option - and don't count on the Fed to "bail out" the real estate market any time soon.