What to Know About Home-Sale Tax Rules

By TOM HERMAN
Wall Street Journal, Sept. 19th 2010

Q: What are the chances that Congress will ease the rules on how long you have to own your home and live in it in order to qualify for the most favorable capital-gains tax treatment when you sell it?

—K.M., Prior Lake, Minn.
A: Slim to none. Naturally, anything is possible if Congress ever decides to overhaul the entire tax system. But don't count on that happening any time soon.

Even if lawmakers do consider major tax-law changes after the November elections or next year, don't expect them to ease the home-sale rules. I haven't heard any significant discussion of this issue among congressional leaders in many years.

Here is how the basic rules work: In the late 1990s, then-President Bill Clinton signed legislation that officials said at the time would eliminate capital-gains taxes for most people who sell their primary home for a profit. That legislation generally allowed most sellers to exclude a gain of as much as $500,000 (if married and filing jointly) or as much as $250,000 (if single).

To qualify for the full exclusion, you typically must have owned the home -- and used it as your primary residence -- for at least two of the five years prior to the sale. For more details, see IRS Publication 523 ("Selling Your Home") on the Internal Revenue Service website (www.irs.gov).

But don't assume you're out of luck if you can't meet the ownership and use tests I mention above. You still might be eligible for a partial exclusion that could greatly reduce -- or even eliminate -- capital-gains taxes on the sale of your primary home.

For example, you may qualify for a partial exclusion if you had to sell your home because of "a change in place of employment" or if you moved for "health" reasons. IRS Publication 523 has other examples.

Here is what the IRS says it means on the health issue: "The sale of your main home is because of health if your primary reason for the sale is: To obtain, provide or facilitate the diagnosis, cure, mitigation or treatment of disease, illness or injury of a qualified individual," or to "obtain or provide medical or personal care for a qualified individual suffering from a disease, illness or injury."

Conversely, the IRS says the sale of your home isn't because of health if the sale "merely benefits a qualified individual's general health or well being."

You also might qualify for a partial exclusion if you had to sell for certain "unforeseen circumstances," such as "natural or man-made disasters or acts of war or terrorism resulting in a casualty to your home, whether or not your loss is deductible."

Credit Scores May Hamper Housing Comeback

By Phil Izzo

Homeownership is potentially out of reach for nearly a third of Americans, according to a new report that highlights the difficulties in the housing market in the wake of the Great Recession.

Potential home buyers may be among the hardest hit by the recession. People with a credit score below 620 who went searching for a loan were unlikely to receive even one quote, according to real-estate web site Zillow.com, even if they offered a down payment of 15%-25%. Zillow notes that 29% of Americans has a credit score this low, according to data provided by myFICO.com.

“Today’s tighter credit is a predictable response by banks after the foreclosure crisis, but also keeps a cap on housing demand, which is important for the greater housing market recovery,” said Zillow chief economist Stan Humphries.

While banks may be right to try to avoid repeating mistakes made during the housing bubble, an over-reliance on credit scores could create problems for the real-estate market. Banks shouldn’t be giving mortgages to borrowers who can’t afford to pay them back, but if people with sizeable down payments and solid sources of income are being turned down because of credit scores, that’s not healthy, either.

Many factors influence credit scores. A temporary spell of unemployment and the resultant hardship can easily push them down. According to a new report from the Pew Research Center, the majority of Americans may find themselves in this situation. Pew separates its respondents into two groups, one that “held its own” — 45%, a number similar to myFico’s estimated 47% of Americans who have the best credit scores (over 720) — during the recession and another that “lost ground” — 55%.

The Pew report’s demographic breakdown may be even more troubling for housing. Those who “held their own” tended to be older people who already owned homes. Real Time Economics recently noted a potential “shadow demand” for housing from people who postponed plans to form new households in the wake of the recession, but that pool of potential homeowners was also more likely to have lost ground during the recession. According to Pew, 69% of people age 18-49 and 60% of those 30-49 lost ground.

It’s likely that those groups, who are the most likely first-time and move-up home buyers, took a hit to their credit scores during the recession. Zillow’s data indicate that even if they’ve recovered from the worst, the may not be able to get a mortgage, and if they do, they also are more likely to face higher interest rates.

Refinancing: Here's What You Need to Know

Refinancing: Whom Can You Trust?

From Conflicts of Interest to Simplistic Formulas, the Web Is Awash With Dubious Mortgage Information. Here's What You Need to Know

By M.P. MCQUEEN

Sept. 18th, 2010

With mortgage rates falling to record lows this summer and the housing market showing signs of a pulse, refinancing activity is perking up.

It's too bad that so many people are relying on oversimplified advice and bad numbers to decide when to pull the trigger.

The refinancing equation has never been more complicated. While some borrowers are desperate to reduce their monthly payments, others are looking to build equity. Some are even treating their mortgage as an investment vehicle, sinking excess cash into their homes in order to secure a lower rate and cut future payments.

Yet most personal-finance resources these days don't account for situations like these. Even essential factors like tax rates and inflation expectations are often ignored in favor of simplistic calculations.

Many popular Web resources, in fact, are financed by lenders, mortgage brokers or "lead generators" that connect borrowers with banks. At times, their advice can be downright harmful.

That's because of the risk involved. Refinancing generally costs 3% to as much as 6% of the outstanding principal of the loan, with banks levying fees on everything from application fees and title searches to appraisal costs and legal expenses.(Mortgage "points" can add to the total, though they typically help reduce the interest rate and lower overall costs.)

Fees are often murky, too, making comparison shopping difficult. The best way to compare deals, says Melinda Opperman of Riverside, Calif.-based Springboard Nonprofit Consumer Credit Management Inc., is to consult with a housing-counseling agency approved by the U.S. Department of Housing and Urban Development.

Given such costs, you don't want to refinance often. Yet the advice coming from the mortgage world suggests you should be doing it regularly.

One particularly dubious idea gaining prominence is the "1% rule," which used to be the 2% rule when rates were higher. The gist: Refinance when you can knock a full percentage point off your rate.

A lead-generation site called Supermortgages.com says the following in a piece called "When to Refinance a Mortgage": "Are the current mortgage interest rates at least 1 point less than your existing mortgage interest? If so, refinancing your home mortgage might make sense."

Wells Fargo & Co.'s website goes further. In an advice article titled "Deciding to Refinance," it writes: "If interest rates are 1/2% to 5/8% lower than your current interest rate, it may be a good time to consider a refinance."

Yet people who followed the one-point rule could have refinanced five or six times in the last 15 years, paying so much in fees that the savings would likely be wiped out.

Supermortgage.com's content largely comes from mortgage brokers, lenders and other industry sources, says Andy Shane, a spokesman for parent company SuperMedia Inc. In this case, he says, the author is a freelance writer with a law degree and a background in real estate who used a mortgage calculator and determined that a one- to two-point cut in rates "made a pretty significant difference in monthly payments" compared with closing costs.

Wells Fargo spokesman Jason Menke says the bank's website has a wide range of information available to help borrowers. "The rate difference cited is just a point where a borrower may want to consider looking into a refinance," he says.

The 1% rule could translate into big business if it catches on. About 71% of outstanding fixed-rate mortgages guaranteed by Fannie Mae or other government-sponsored entities are at least a point above current rates, according to Walter Schmidt, senior vice president at FTN Financial Capital Markets in Chicago.

Bills.com is another lead-generation site that offers personal-finance advice. Its new refinance calculator is among the most basic around: It asks users for some data and their reason for wanting to refinance and then spits out a yes/no answer.

The answer, however, is usually "yes." And sometimes it comes with a suggestion for a risky interest-only loan. It also provides a way for users to sign up for a quote.

Ethan Ewing, president of Bills.com, says the calculator's simplicity and ease are virtues. Most users say they are looking for a fixed-rate loan or a lower monthly payment, he says. "If [users] can save more than $100 a month on the payment with a new mortgage, the calculator says 'yes.' "

Another flawed concept is the standard break-even test. Many mortgage sites suggest that borrowers should calculate how many months it would take to save enough on mortgage interest charges to break even on the closing costs, and then to pull the trigger when the payoff goes below three to five years.

But such analyses often ignore important factors, such as how long the borrower plans to stay in the house or the borrower's tax rate, which determines a loan's after-tax cost.

Consider LendingTree.com, a lead generator, broker and lender. In an article called "When Does It Pay to Refinance a Mortgage?" it warns: "There are other things to consider when you refinance, too, including taxes and private mortgage insurance. For a break-even estimate that takes many of these factors into account, use the LendingTree refinancing calculator."

The problem: The refinance calculator doesn't take taxes into account. It merely calculates your break-even point based on your current payment, the hypothetical new-loan payment, and the closing costs. Right below the results is a button to "start request"—meaning it will start to hook you up with a lender.

"This is a simple calculator that gives you a straightforward break-even equation," says Nicole Hall, a spokeswoman for LendingTree. "You should speak to a loan officer to thoroughly evaluate your options.... Generally, if you can lower your interest rate by 1%, you are saving enough to justify the refinance if you are staying in the home a certain number of years."

Versions of the same calculator appear on the sites of mortgage brokers or lead generators such as Domania.com and Calculators4Mortgages.com.

There are, to be sure, plenty of websites whose advice is unbiased and sound. The Federal Reserve, for example, offers a refinance resource page on its website that includes a better break-even calculator with tax-rate considerations.

A more-sophisticated calculation of the merits of refinancing would include other factors: the borrower's tax rate, inflation expectations, how long the borrower plans to live in the house, the opportunity cost of paying closing costs rather than investing in stocks or bonds, and so on.

One obscure calculator comes close. Instead of plugging in today's mortgage rates and determining how long it would take to pay back the closing costs, it uses "optimization theory" to conjure up a person's ideal refinance rate regardless of where rates are now. If you can find a rate that is equal to that rate or lower, it's time to refinance.

The bad news: Its results tend to flash the green light much less often than other calculators.

The calculator, posted on the National Bureau of Economic Research's website at http://zwicke.nber.org/refinance/index.py, is based on a 2008 paper by two economists at the Federal Reserve and one from Harvard University. Using stochastic calculus, they devised a formula based on the loan size, the homeowner's marginal tax rate, the expected inflation rate over the life of a loan, how long the borrower plans to remain in the house and other factors.

"These ideas are really old hat among economists; our contribution is deriving a simple formula that anyone can plug into their calculator or computer," says Harvard professor David Laibson, one of the authors.

The Optimal Refinance Calculator spits out tougher numbers than many other calculators in part because it factors in the benefit of waiting beyond the break-even for the chance that rates could fall further. Refinance now and you reduce your ability to refinance later.

According to the calculator, a borrower in the 35% tax bracket who has 20 years left on a $400,000 mortgage at 5.88% isn't advised to refinance until rates hit 3.92% (assuming low closing costs of 3%). By contrast, a three-year break-even analysis of those parameters would suggest that today's 4.5% rate is the time to make a deal.

"Some people mistakenly think [the break-even] is a recommendation to refinance," Prof. Laibson says. "You want to wait until things get better than the break-even point. Refinancing is irreversible and really costly."

Another way to benefit from falling rates in the future is via an adjustable-rate mortgage, the norm in places such as the United Kingdom and Australia. People with a strong conviction that deflation will unfold over the next several years can take out an ARM now and refinance later if rates start to head upward, though the transaction costs could add up.

Be warned: The Optimal Refinance Calculator doesn't account for refinancing into shorter-term loans, such as 15- or 20-year mortgages. It also doesn't work for "cash in" refinance deals, which investors increasingly are viewing as investments unto themselves. The bet: With stocks in a 10-year slump and bonds looking bubbly, the best investment they can make is to cut their future mortgage payments.

A new cash-in mortgage refinance tool, launched on Aug. 25 at www.mtgprofessor.com, calculates the "internal rate of return" on the cash a borrower puts into an underwater home loan to pay off the balance and cover closing costs. The money saved each month and the balance reduction is treated as a return on the cash invested. Compare that with your expected returns on stocks or bonds to see if a refinance makes sense.

Jon Krieger, 34 years old, and wife April, 32, of Blairsville, Ga., didn't need to invest extra cash—they simply wanted to cut their mortgage payment. Mr. Krieger says he tried several times last year to refinance but couldn't because bank lending standards were too tight.

It's a good thing they didn't refinance last year. Rates have since fallen even lower—precisely the possibility the Optimal Refinance Calculator considers.

In August the couple refinanced their $416,000, 6.75% loan they took out in May 2007 with a new loan at 4.75%. It lowered their monthly payment by more than $500. The total closing costs were about $5,500, says Mr. Krieger.

The deal easily satisfies the 1% rule and the three-year break-even. It also survives the Optimal Refinance Calculator, which put the Kriegers' ideal rate at 5.63% or below.

"We just kept plugging away and finally this came along, and it worked out real well," says Mr. Krieger. "I was very pleased."

Write to M.P. McQueen at mp.mcqueen@wsj.com

Government launches plan to help 'underwater' borrowers

Tues. Sept. 7th 2010
AP Staff

WASHINGTON -- The Obama administration is trying to jump-start its sputtering attempts to tackle the foreclosure crisis with an effort to assist homeowners who owe more on their properties than their homes are worth.

Starting Tuesday, the Federal Housing Administration will permit lenders to give these borrowers refinanced loans backed by the government. The lenders will be required to forgive at least 10 percent of the original mortgage amount. Investors who have control over the mortgages as part of their large portfolios will select which borrowers are invited to participate.

The plan was first announced in March. Its rollout represents the latest of numerous efforts by the administration to address the housing bust. So far, the government has only nibbled around the edges of the crisis, as its programs have run into numerous problems.

The lending industry was ill-prepared for a crush of distressed homeowners, the economy worsened and millions of homeowners had taken on so much debt that their financial woes have been nearly impossible to resolve.

Nearly half of the 1.3 million homeowners who have enrolled in the Obama administration's main mortgage-relief program -- overseen by the Treasury Department -- have already fallen out over the past year.

Many borrowers say the government program is a bureaucratic nightmare, with banks often losing their documents and then claiming borrowers did not send back the necessary paperwork. Banks say borrowers often didn't return the required documents.

The new refinancing program takes a different approach. It allows investors in mortgage-backed securities to evaluate their holdings and select borrowers that will be offered refinanced mortgages guaranteed by the FHA.

The theory is that there are some loans that investors simply want to unload because they have a high risk of default.

However, when faced with the choice between slashing the amount borrowers owe on their home loans and foreclosing, lenders have generally chosen to foreclose on borrowers. Many experts doubt the new program will persuade investors to change their minds.

Government officials acknowledge that getting the plan going will be complicated. FHA Commissioner David Stevens said in a statement that it "requires significant coordination and operational execution by several parties to be successful."

The government estimates that between 500,000 and 1.5 million homeowners could be helped. But Stevens said the number of borrowers who actually benefit will likely be toward the low end of that range.

Even so, Keefe, Bruyette & Woods Inc. analyst Bose George called the government's estimates "extremely optimistic." George said investors are likely to only offer refinances to borrowers who have seen their home values plunge to the point where they owe 40 percent more than their home's current value. Those homeowners, he said, are in danger of walking away from their mortgages.

"We're assuming that the impact is minimal," he said.

To qualify, borrowers must be up-to-date on their mortgages, though many people who have already received loan modifications through other programs are still eligible. The plan is limited to loans in which homeowners owe at least 15 percent more than their home's current value.

Analysts at Barclays Capital estimated last month that the refinancing program would only aid between 200,000 and 300,000 homeowners. If it reaches that many, it would be a small share of the number of Americans with so-called underwater mortgages.

As of the end of June, about 11 million U.S. homes, or 23 percent of those with a mortgage, were in this position, according to real estate data provider CoreLogic.

No Money Down Programs Creep Back Into the Marketplace

NY Times, 9/4/10

When the housing bubble burst, one of the culprits, economists agreed, was exotic mortgages, including those that required little or no money down.

But on a recent evening, Matthew and Hannah Middlebrooke stood in their new $115,000 three-bedroom ranch house here, which Mr. Middlebrooke bought in June with just $1,000 down.

Because he also received a grant to cover closing costs and insurance, the check he wrote at the closing was for 67 cents.

“I thought I’d be stuck renting for years,” said Mr. Middlebrooke, 26, who earns $32,000 a year as a producer for a Christian television ministry.

Although home foreclosures are again expected to top two million this year, Fannie Mae, the lending giant that required a government takeover, is creeping back into the market for mortgages with no down payment.

Mr. Middlebrooke’s mortgage came from a new program called Affordable Advantage, available to first-time home buyers in four states and created in conjunction with the states’ housing finance agencies. The program is expected to stay small, said Janis Smith, a spokeswoman for Fannie Mae.

Some experts are concerned about the revival of such mortgages.

“Loans that have zero down payment perform worse than loans with down payments,” said Mathew Scire, a director of the Government Accountability Office’s financial markets and community investment team. “And loans with down payment assistance” — like Mr. Middlebrooke’s — “perform worse than those that do not.”

But the surprise is the support these loans have received, even from critics of exotic mortgages, who say low down payments themselves were not the problem, except when combined with other risk factors like adjustable rates or lax underwriting.

Moreover, they say, the housing market needs such nontraditional lending, as long as it is done prudently.

“This is subprime lending done right,” said John Taylor, president of the National Community Reinvestment Coalition, an umbrella group for 600 community organizations, and a staunch critic of the lending industry. “If they had done subprime this way in the first place, we wouldn’t have these problems.”

At Harvard’s Joint Center for Housing Studies, Eric Belsky, the director, said the loans might be the type of step necessary to restart the housing market, because down payment requirements are keeping first-time home buyers out.

“If you look at where the market may get strength from, it may very well be from first-time buyers,” he said. “And a very significant constraint to first-time buyers is the wealth constraint.”

The loans are the idea of state housing finance agencies, or H.F.A.’s, quasi-government entities created to help moderate-income people buy their first homes.

Throughout the foreclosure crisis, the state agencies continued to make loans with low down payments, often to borrowers with tarnished credit, with much lower default rates than comparable mortgages from commercial lenders or the Federal Housing Administration. The reason: the agencies did not offer adjustable rates, and they continued to document buyers’ income and assets, which many commercial lenders did not do. In 2009, the agencies’ sources of revenue dried up, and they had to curtail most lending.

Then they created Affordable Advantage. The loans are 30-year fixed mortgages, with mandatory homeownership counseling, available to people with credit scores of 680 and above (720 in Massachusetts). The buyers have to put in $1,000 and must live in the homes.

All of these requirements ease the risk, said William Fitzpatrick, vice president and senior credit officer of Moody’s Investors Service. “These aren’t the loans that led us into the mortgage crisis,” he said.

So far Idaho, Massachusetts, Minnesota and Wisconsin are offering the loans. The Wisconsin Housing and Economic Development Authority has issued 500 loans since March, making it the first state to act. After six months, there are no delinquencies so far, said Kate Venne, a spokeswoman for the agency.

The agencies buy the loans from lenders, then sell them as securities to Fannie Mae. Because the government now owns 80 percent of Fannie Mae, taxpayers are on the hook if the loans go bad.

The state agencies oversee the servicing of the loans and work with buyers if they fall behind — a mitigating factor, said Mr. Fitzpatrick of Moody’s.

“They have a mission to put people in homes and keep them in homes,” not to foreclose unless other options are exhausted, he said. The loans have interest rates about one-half of a percentage point above comparable loans that require down payments.

Ms. Smith, the spokeswoman for Fannie Mae, distinguished the program from loans of the boom years that “layered risk on top of risk.”

With the new loans, she said, “income is fully documented, monthly payments are fixed, credit score requirements are generally higher, and borrowers must be thoroughly counseled on the home-buying process and managing their mortgage debt.”

For Porfiria Gonzalez and her son, Eric, the loan allowed them to move out of a rental house in a neighborhood with a high crime rate to a quiet street where her neighbors are retirees and police officers.

Ms. Gonzalez, 30, processes claims in the foreclosure unit at Wells Fargo Home Mortgage; she has seen the many ways a mortgage holder can fail.

On a recent afternoon in her three-bedroom ranch house here, Ms. Gonzalez said she did not see herself as repeating the risks of the homeowners whose claims she processed.

“I learned to stay away from ARM loans,” or adjustable rate mortgages, she said. “That’s the No. 1 thing. And always have some emergency money.”

When she first started shopping, she looked at houses priced around $140,000. But the homeownership counselor said she should keep the purchase price closer to $100,000.

“They explained to me that I don’t need a $1,200-a-month payment,” she said.

The counselor worked with her real estate agent and attended her closing. On May 28, Ms. Gonzalez bought her home for $90,500, with monthly payments of $834. After moving expenses, she has kept her savings close to $5,000 to shield her from emergencies.

“If I had to make a down payment, it would have wiped out my savings,” she said. “I would have started with nothing.”

Now, she said, she is in a home she can afford in a neighborhood where her son can play in the yard. A neighbor brought her a metal pink flamingo with a welcome sign to place by her side door.

“My favorite part is the big backyard,” said Eric, 10. “And that’s pretty much it.”

“You don’t like it that it’s a quiet, safe neighborhood?” his mother asked.

“Yeah, I do.”

“He didn’t go out much with kids in the old neighborhood,” she said.

“Because they were bad kids,” he said.

Ms. Gonzalez said that owning a house was much more work than renting, and that when the basement flooded during a heavy rain, her heart sank.

“But I look at it as an investment,” she said, adding that a similar house in the neighborhood was on the market for $120,000.

Prentiss Cox, a professor at the University of Minnesota Law School who has been deeply critical of the mortgage industry, said the program met an important need and highlighted the track record of state housing agencies, which never engaged in exotic loans.

“It’s not a story people want to hear, because it won’t bring back the big profits,” Mr. Cox said. “The H.F.A.’s have shown how the problems of the last 10 years were about having sound and prudent regulation of lending, not just whether the loans were prime or subprime.”

He added, “One of the great and unsung tragedies of the whole crisis was the end of the subprime market.”

How to Navigate Short Sales

How can you get in on a good short-sale deal? It takes a certain amount of fortitude and patience, plus a lot of luck.

What's a short sale?

Selling a home for less than the amount the current owner owes the mortgage company is called a short sale.

Buying a home that is a short sale is different from buying a property that is actually owned by the bank, known as an REO, or real-estate owned property, or a property that is in foreclosure.

All of this sounds arcane, but it's lingo that anyone shopping for a home needs to understand to navigate today's marketplace.

A short sale can be a good deal for a buyer, and it can help the seller avoid having a full foreclosure on his or her credit record. Although a short sale and a foreclosure negatively affect the seller's credit score, in a short sale the damage can be minimized if the homeowner can persuade the lender to report the debt to credit bureaus as "paid in full."

In a short sale, the proceeds from the transaction are less than the amount the seller needs to pay the mortgage debt and the costs of selling. For this deal to close, everyone who is owed money must agree to take less -- or possibly no money at all. That makes short sales complex transactions that move slowly and often fall through.

An extension of the government's housing rescue plan could make it easier to buy short-sale properties. The new version of the Making Home Affordable plan will pay lenders up to $1,000 if they allow a short sale of a property when the owners don't qualify for loan modification because they owe too much money on the home. The program will spell out a short-sale process and provide standard documents, the U.S. Treasury says.

The government's plan probably still won't help if there are multiple liens on the property, but it should encourage lenders holding the first mortgage to move the process along.

Keep your eyes wide open

If you're house hunting and spot what seems like a great deal, chances are good that you are considering a short-sale property.

Most of the time, the seller has already fallen behind on the mortgage, but occasionally the seller is current but unable to continue to pay because of ill health or job change. This is particularly true in parts of the country where home prices have fallen significantly.

Before you rush in, consider the issues. The advice below comes from Scott Thompson, senior vice president of Mortgage Resolution Services, a distressed sales consulting company, and Vicki Vidal, associate vice president of government affairs for the Mortgage Bankers Association.

Know what you are getting into. Under the best circumstances, short sales take a long time to close and may require extra effort on the part of the buyer. Walking blindly into a short sale can be a losing and distressing proposition, so push for disclosure before you get involved, Thompson says.

This is not a do-it-yourself project. Find a real estate professional who understands the territory. Having a real estate agent on your side who knows how short sales work and who has negotiated others will increase the chances of closing the deal.

"I would ask the agent to provide references, specifically on an REO or a property that was in short sale," Thompson says. "You certainly don't want someone who is a shrinking violet."

Thompson and Vidal advise staying away from "short-sale counselors," those who say they can jump in and expedite the deal. Their game often involves negotiating a low price with the lender, charging the buyer more money -- often significantly more money -- and pocketing the difference. This "counselor" probably won't make the deal go any more smoothly for you and certainly won't do you any favors pricewise.

Be wary of the condition of the property. If the seller is in financial distress, chances are the home may not be well-preserved. The seller also may be reluctant to reveal serious maintenance issues. Proceed cautiously and get the property inspected by a knowledgeable person before you commit.

Make sure the deal has a prayer of closing

If you've decided to go for it, the first step is to have your real estate agent talk to the real estate agent representing the seller and determine the status of the short sale. Below are items that most lenders require from a short seller. If the seller is unable or unwilling to provide this information, the short sale won't close and any buyer is wasting his or her time. Your real estate agent should push for candor from the seller's agent.

A hardship letter. The seller must explain why he or she cannot continue making payments. The sadder the story, the better. A seller who is simply tired of struggling probably won't be approved, but a seller with cancer, no job and an empty bank account may.

Proof of income and assets. If the seller has money in the bank, including retirement funds, it is unlikely that the lender will let the debt slide. This package of information must include income tax and bank statements, going back at least two years. Sometimes sellers are unwilling to produce these documents because they conflict with information on the original loan application, which may have been fudged. If that's the case, this deal is unlikely to close.

Comparative market analysis. This document shows that the price of the property has declined and that the property won't sell anytime soon for the amount owed. This packet of information should include a list of comparable properties on the market and a list of properties that have sold in the past six months or have been on the market in that time frame and are about to close. This packet of information is similar to what's known as a Broker Price Opinion, which is less formal but often more informative than a property appraisal. The prices should support the seller's contention that the property is worth no more than the short-sale price.

A list of liens. There may be more than one, so determine how many liens are on the property. The good news is that since late 2008, the IRS has been willing to release a federal tax lien. The IRS is not forgiving the back taxes that homeowners owe; it is just no longer requiring that the lien be paid off before the property can be sold. And a single mortgage lien is an easy problem to solve.

If there are first and second mortgage liens, the question becomes: What's the plan to satisfy these lien holders? The seller and the real estate agent should have a plan that is more sophisticated than crossing their fingers, Thompson says. In the best of all possible worlds, the seller will be willing to contribute to paying off the second lien, so the first lien holder gets the full amount from the sale.

If there is a third mortgage lien, reaching any deal is very iffy. Deal killers include child support liens, state tax liens and homeowners association liens. If they exist and there are no obvious solutions, walk away, Thompson says.

Here's one more deal killer, something that can be difficult to sleuth out, says Thompson. Because a short sale generally doesn't cover the whole amount owed or other liens, it can trigger mortgage insurance. If the property is covered by a mortgage insurance policy that doesn't have to pay off until the home has been in foreclosure for 150 days or some similar length of time, chances are the insurer will hold up the sale because it won't want to pay any earlier than necessary and hopes the foreclosure will just disappear. Often the mortgage insurer will simply go silent. Thompson says: No response, no approval.

Be realistic

The bottom line: Don't choose a short sale if you're in a hurry.

"It's a waiting game," says Vidal.

Part of what slows down short sales is buyers' insistence on making really lowball offers, she says. "You get really crazy, ridiculously low offers -- and they are rejected."

Another factor is the increasing number of government programs aimed at keeping people in their homes -- about 50 percent of defaults never go as far as foreclosure, according to the Mortgage Bankers Association. So lenders see short sales as potentially the least attractive option and aren't willing to expedite them.

How can a potential short-sale buyer be protected from getting involved in an extended negotiation that doesn't go anywhere in the end? Thompson says you should negotiate an agreement with the seller and the seller's real estate agent that your offer will be the only one presented to the lender. If the lender isn't flooded with offers, it will be more motivated to move forward. If the lender turns down the offer without countering, then the restriction disappears.

Once you've crafted a deal, you better know where the money is coming from to close. If you're getting a loan, you need bank approval in advance.

As is true with any of these deals -- REOs, short sales, foreclosure auctions -- make sure you have money lined up. Cash is the best financing alternative in these cases.