The future has a way of arriving unannounced. George Will After a long period of low interest rates and high equity gains, the real estate market is coming back down to earth. New investors may be wondering, right about now, whether they made a big mistake in quitting their day jobs. Is it time to enroll in truck-driving school?

Never fear: Rising interest rates and slower equity gains mean big bucks for savvy investors. The key to making money in this new economy is in knowing how to build instant equity by short-selling second mortgages.

Before I talk about short sales, though, let’s review the recent changes in the economy to put the discussion in context. Until very recently, interest rates were going nowhere but down. The high interest rates of the late 1970s had been replaced by interest rates as low as 3%. The principal and interest for a quarter-million-dollar mortgage at 4.5% was only $1,267, compared with $1,663 for the 7% mortgage a homebuyer might have had just a few years earlier. And adjustable rate mortgages helped even borderline buyers get homes.

In the meantime, real-estate prices continued to rise at astonishing rates, especially in places like Florida and Arizona, where average prices in some cities have gone up close to 40% in one year. Nationally, home prices rose almost 13% last year, twice the historical average of 6.4% And in my home town of Atlanta, which has been known for stable, reasonable home prices, the average price of a typical 2,200 square foot, 4 bedroom, 2 ½ bath home rose to $303,000 in 2005.

These events have helped more than just real-estate investors. Owning a home became feasible for many Americans who had previously been unable to qualify for financing. And once settled in a home, it became easier than ever to take out equity loans to make improvements or pay off credit card debt. Many lenders were willing to loan 125% of home value. Thinking they couldn’t lose in this housing boom, a lot of homeowners took the bait in the form of higher-interest second mortgages.

Many of us rode in on this tide of low interest rates and high equity gains, and if we’ve worked hard and worked smart, we’ve done very well. But the real-estate market is changing. The Fed is raising interest rates, and the incredible rate of price increases is slowing down.

Where does this leave homeowners? Unfortunately, it leaves many of them severely overextended. Those who took out adjustable-rate mortgages are finding their payments going up, perhaps beyond what they can afford. Homeowners who took on second mortgages are in the worst possible position. Sometimes they’ve had a change in circumstances and making the rising payments has become more difficult or even impossible.

Many of these homeowners decide to sell their homes rather than face foreclosure, but they’re in for a nasty shock. The value of their home has not continued to appreciate at the same pace. Or perhaps they over-improved their home using money from the second mortgage. Either way, they can’t sell for enough money to pay off both loans.

In times past, homeowners may have considered bankruptcy to charge off unsecured loans and lower their debt load; this would have made it possible to continue making mortgage payments. However, in late 2005 the law changed, closing off that option for many Americans.

Are homeowners left with no options but foreclosure? There aren’t many, unless the lender is willing to take a deed in lieu of foreclosure. And any of these options can have a negative impact on the homeowner’s credit, even though the circumstances that brought hardship may have been completely out of his control.

Is there another option? Well, that’s where you – and the short sale – come in. The short sale is an advanced technique, but it’s a must-have investment tool in this changing economy. It’s so important that I’ve made it one of the three primary courses I teach and the tactic I employ over and over again to create equity where there appears to be none.

Here’s how it works: Let’s say a homeowner has a house with an after-repair value of $140,000. There’s a first-mortgage balance of $100,000, a second-mortgage of $35,000, and the house needs $5,000 in repairs. And let’s say that the homeowner has fallen behind in payments due to some hardship and is facing foreclosure.

Now, the average investor sees zero profit in that house. However, I see $30,000 worth of equity. How? By paying the second mortgage holder $0.15 on the dollar – in other words, just $5,250 – to settle the second loan, I lower the indebtedness from $135,000 to just $105,250. And that’s not all. Since rising interest rates translate to rising rental rates, I can also turn that home into higher month-to-month cash flow if I choose to lease the house for a while.

Let’s slow it down a bit for the less experienced investors. Remember, the home will only be worth $140,000 after I make the repairs. However, the homeowner owes $135,000 for both mortgages, and repairs will cost $5,000. That means that the house will cost me as much as it’s worth – or so it would seem.

But I’m going to buy the house “subject to” the existing financing. Basically, I’m going to take over payments on the existing first mortgage and leave it in place. I’m not going to negotiate a short sale with the first-mortgage holder, because he’s got no incentive to bargain with me. He figures he’ll recoup his loan at “the steps” – the foreclosure auction, or take the house back as “real estate owned” and then sell it on the retail market.

Instead, I’ll talk to the second-mortgage holder. If the house goes to the steps, they’ll lose everything, unless they buy it themselves. So, I’ll show them pictures of the repairs that are needed to prove that the house is more trouble than it’s worth. And in the end, I’ll settle with them for pennies on the dollar. That will eliminate one of the loans, leaving only the first mortgage in place. The house is worth easily in excess of that $100,000 loan – and that excess is going to turn into profit when I sell.

Before I buy it, I’ve also lined up a private lender. My lender will give me a loan large enough to bring the first mortgage up to date (if they’re behind), pay off the shorted second, make monthly payments, do the repairs, and market the property. So I’ll use none of my own money in the deal.

Some people might feel that short-selling exploits people in crisis. I see it differently: I’m helping the homeowner avoid foreclosure when they are working themselves out of a difficult situation. And any of us is one hardship away from finding ourselves in the same position. So I treat homeowners like I’d want to be treated.

You might wonder why a bank would short-sell a second mortgage. After all, it has a lien on the house. Why would it settle for less than what it’s entitled to? There are a number of reasons:

• Because it’s a second or third mortgage, the bank is in a junior lien position. If the property goes to foreclosure, the bank may never see a penny.
• The property may need extensive repairs. Lenders do not want to renovate houses. They would rather slash the price and get rid of the house. They are disinclined to throw good money after bad.
• The property could be in a bad area or a “war zone.”
• There could be too many real-estate owned homes (REOs) in the bank’s inventory. Banks don’t want houses. If they get an overflow of REOs in their department, they’re penalized by the Federal Reserve and by stockholders because they can’t lend out as much money.

These are the five steps to follow to short sale a property:

• Marketing yourself.
• Finding the property.
• Working with the seller.
• Working with the lender.
• Renovating and selling.

The short-sale method isn’t a get-rich-quick scheme, because it’s essential to market your business and do the footwork. But it is a proven method for building equity and cash reserves fast.

So before you sign up for truck-driving school or try to get your old job back, make sure you’ve fully explored all your options. With education and hard work, you can keep the money flowing.