With all of the recent press about the crash of the sub-prime lending market, we will be seeing more and more "short sales." What's a short sale?
A short sale occurs when a seller is in a negative equity position and either does not have the liquidity to sell (that is, they need to come to the settlement table with funds to cover their loss) or is facing foreclosure but wants to avoid it. This situation happens when the seller owes more on the property than it is currently worth. It's being "underwater" or "upside down" on the mortgage.
Lenders in this situation often cooperate with the seller because it will maximize their payoff to do that versus foreclosing and selling the property at auction. Upon settlement, the lender receives all of the net proceeds (less closing costs), which is called the "short payoff." The lender, despite being owed more money, releases the lien anyway and the buyer gets title. Lenders must agree to cooperate in this up-front, and contracts are contingent on lender approval.