We're all taking a hit to our wallets--gas prices, insurance rates, property taxes. These are just a few of the factors that are contributing to the record foreclosure rates our nation is facing. To put it into solid numbers, RealtyTrac says "1.2 million foreclosure filings were reported nationwide during the year (2006), up 42 percent from 2005.".

The current surge in foreclosure rates is a stark contrast to the historically low levels of foreclosures we've seen over the past several years. Property values were high, so homeowners on the brink of foreclosure could easily sell their home and get out from under their debt. But now troubled homeowners are facing stagnant appreciation levels and spiking adjustable rate mortgages.

The short sales strategy

As a real estate investor, all these foreclosures mean that the iron is hot for the striking. But you don't want to just charge in like a bull in a China shop. Instead, focus your time and energy on making short sales.

A short sale occurs when the lender is willing to take less money than what is actually owed on the mortgage. Basically, the lender can see that the prospects of a full recovery are fairly dim, so they're willing to cut their losses. For example, suppose Homeowner Joe owes the lender $240,000 on a home valued at $260,000. Homeowner Joe gets a short sale offer of $225,000 on the house. If the lender will accept that amount (and accept the $15,000 loss) as payment in full for the unpaid balance of the loan, then you've successfully completed a short sale.

Who benefits from a short sale?

The short answer: everybody! The homeowner has avoided foreclosure, as well as a huge stain on their credit history. The lender has avoided the expenses of a foreclosure and the hassle of trying to sell the home themselves. You've benefited because you just purchased a home with an automatic $35,000 in equity.

The best candidates for short sales

You can do a short sale with a bank-owned home. However, the ideal candidate is a homeowner who's on notice that they're in default but has not actually been foreclosed on. The reason for this goes back to the benefits of short sales in general. Both the lender and homeowner are eager to avoid foreclosure all together. If the foreclosure has already occurred, the bank is less motivated to accept a price that's insufficient to cover the outstanding debt.

As for the property itself, look for homes that are over-leveraged or have multiple mortgages. An over-leveraged property is one that has mortgages totaling more than the market value of the property. The lenders who financed the second or third mortgages are totally out of luck if a foreclosure happens. They'll basically get nothing. Naturally, these lenders in particular are happy to take what they can get.

A third type of home to look for is one that's in poor cosmetic shape. You might be willing to invest sweat equity in a "fixer upper", but a bank isn't. The more work the house needs, the bigger the hassle for the lender. And if there's one thing that every real estate investors knows, it's that you can always cash in on a lender's aversion to a hassle.

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