Nearly three years after it began, the housing slump continues to batter homeowners. In Tucson, the median home sales price in September was down over 10% from a year before. As of June 30, about 23% of homeowners with mortgages nationwide and 50% in Arizona were “underwater”, or owed more than the value of the house (according to First American Home CoreLogic, a real-estate information company). Here are some of the options for underwater homeowners.

Modify it – The federal government has implemented several programs to try and help people stay in their homes and ease the damage to the economy and financial system. Initially, the Home Affordable Modification Program (HAMP) was designed to lower the rate and extend the length of mortgages, thereby reducing monthly payment amounts, but it did not reduce the balance owed. Available for principal residences acquired prior to 2009, it applied if the original mortgage payment exceeded 31% of the homeowner’s gross income.

The next phase in July, 2010 was the Home Affordable Foreclosure Alternative Program (HAFA) and it included incentives for lenders to participate. A mortgage modified under HAFA would not include a deficiency judgment, or an attempt by the lender to later collect the amount of the forgiven debt. (Arizona is one of 12 states that already have non-recourse mortgage loans, which means that lenders can only rely on the value of the house to recover amounts owed for the acquisition of a principal residence.) HAFA provides $3,000 to the homeowner for relocation expenses, $1,500 for the lender to offset its costs and up to $2,000 for payment on a second mortgage.

In September, the “short refinance” program was announced to assist underwater homeowners who have kept up with their mortgage payments. This program applies to properties with debt up to 115% of the current value and with mortgages not already guaranteed by the government. The lender must agree to reduce the loan balance by at least 15% or more so that the new loan is no more than 97.75% of the current value. The homeowner must still have adequate income and credit record and must pay transaction fees. In return for reducing the loan amount, the lender gets a new loan at today’s interest rate that is guaranteed by the Federal Housing Administration (FHA).

All of these programs have faced three major obstacles. First, most mortgage loans have been sold by the original lenders to other investors, and those sales include terms that can make modification difficult. Second, many homeowners have second and third mortgages, and some of that debt does not qualify for relief. Getting one lender to cooperate is hard enough, but getting several lenders to agree on allocating the loss is incredibly difficult. Finally, the bureaucracy and confusion of dealing with lenders and government agencies have left many homeowners frustrated; stories abound of homeowners working for months in good faith on a loan modification, only to have it fall apart and result in much higher accumulated payments. As a result, only a fraction of potential loan modifications have taken place, and as many as 40% of modified loans end up in default again.

Let it go – Despite theemotional toll, sometimes the best option is to get rid of the house. The Mortgage Relief Act of 2007 addressed the situation where the amount of forgiven debt is included as taxable income. Through 2012, any reduced, forgiven or unpaid debt incurred to buy, build or improve a principal residence will be excluded from income.

The homeowner can try to dispose of the house through a “short sale” in which the lender agrees to accept a sales price less than the amount owed. In such a difficult real estate market, it is important to work with a real estate agent who is experienced with short sales, price the property aggressively and be willing to reduce the price. It is also worth considering selling the house for less than the amount owed and paying the difference to the lender at closing; this avoids the negotiation delays of a short sale and preserves the seller’s credit score.

Another option is a deed in lieu of foreclosure, which simply involves the homeowner deeding the house to the lender to avoid foreclosure. The forgiven debt is not taxable and in Arizona the lender cannot pursue payment of the shortfall. However, any debt that was not related to the acquisition or improvement of the property can be pursued by the lender. Finally, there is foreclosure, which occurs when the lender evicts the homeowner for non-payment of the loan and takes title to the house. The glut of foreclosures has increased the average time between default, or stopping payment, and foreclosure to 16 months. The recent revelation that lenders were not properly verifying documents before foreclosure has caused even more confusion.

Stay and pay – If the homeowner is able to make the mortgage payments and can still afford and enjoy the house, it may make sense to stay put and pay the mortgage as agreed. (For homeowners who choose to keep the house and have not already refinanced, it may even make financial sense to add cash to take advantage of lower fixed rates.) Staying in a house that is underwater requires recognition of the house as a residence rather than as an investment and acceptance that its market value may never reach the amount owed. But in comparison to the emotional and financial costs of other options, this may be the best choice.

All of these options can take a significant financial and emotional toll, and other than paying the loan, each can significantly impact the homeowner’s credit score and ability to borrow in the future. In many cases, rapidly deteriorating finances may leave the homeowner with little choice. But if you find yourself underwater, it is best to step back and take as objective a look as possible while options are still available.