Banks trimmed 1.2 million troubled mortgages or foreclosed homes out of the massive shadow inventory hanging over the housing market in the first half of 2012, according to JPMorgan Chase (JPM) research.

The progress could double by the end of the year, though more than 4 million loans and properties would remain. Still, that would be down from a peak of 6 million in 2010.

The nearly 335,000 short sales completed in the first half neared the 420,000 modifications done. Another 470,000 in REO sold as well.

The $25 billion foreclosure settlement with the five largest mortgage servicers in March resulted in many more short sales than modifications.

Chase analysts expect the AG settlement could result in 100,000 principal reduction mods for an average of $100,000 reduced for each borrower. Servicers would have to rally in the back half of 2012 to get there. A total of just 7,000 were completed through June, but banks said they began ramping up offers over the last two months.

By the end of the year, servicers could sell more than 950,000 foreclosed homes and another 670,000 properties through short sale. Analysts expect 800,000 modifications total for 2012.

Estimates on the shadow inventory vary based on how delinquent a loan must be before researchers add it to the pile. Chase estimates include loans that have gone at least 60 days without a payment. Still, the consensus is that banks are making progress and with it, house prices will also improve.

This could then help solve the other major drag on housing: the amount of borrowers stuck making payments on a loan they owe more on than their house is worth.

Should prices increase another 10%, the 10.8 million underwater borrowers could drop to 9 million, Chase estimates.

“Although re-defaults and new delinquencies will continue to keep shadow inventory elevated, the rapid decline should prevent downward pressure on home prices going into 2013,” analysts said. “Combined with better existing home sales, investors have reason to be optimistic about running recovery scenarios.”

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