Legal Question in Real Estate Law in California

You don't have a legal problem here unless you have some basis to contest the debt or you want to file bankruptcy. If you don't pay, don't file suit contesting the debt for some reason (not likely you have one), and don't file for bankruptcy, they will foreclose.

Your income tax returns are your best proof of income from self employment. That's one of the benefits of reporting all your income. With a 638 credit score and decent (honest) tax returns and a decent payment record, you should be able to refinance, although not on the best terms. Start with your first lender (GMAC) and explain the whole deal to them. Fortunately, interest rates are currently quite low although lending standards are high - a good reason to shop where you are already known. If your tax returns aren't something you want to share with lenders, for whatever reason, you're going to have a much more difficult time. I'm also doubtful that you'll be able to negotiate for a principal reduction; they'll just foreclose, especially since there is equity in the property.