Legal Question in Real Estate Law in California

First, if your bank refuses to modify or refinance your loans, it may also refuse to participate in a short sale, although I would encourage you to inquire, because the criteria are somewhat different.

Next, the short sale should be negotiated to encompass the 2nd mortgage, and both should be paid off, without recourse, in the short sale. I believe there is now legislation in California that requires short sales to be final, with no further borrower liability, and while I am uncertain how this would apply to a 2nd from the same lender, I would encourage you to insist on termination of all liability on both loans.

Note that many banks will not negotiate short sales unless the borrower is already in arrears, or possibly already in default, and that the bank is not required to do short sales.

So, ability to do a short sale is not guaranteed, and indeed is not the borrower's final recourse. That would be foreclosure. Other options available to you may include bankruptcy or, at the other extreme, continuing to make payments after the loan resets. Do you know what your new payment will be? Maybe wait until the reset occurs?

Also, let's see what other LawGuru attorneys have to say.