In a short sale, the seller arranges with their mortgage lender to accept a price that's less than the amount they owe on the property. As part of this arrangement, the lender typically agrees to forgive the rest of the loan. As a result, the seller doesn't have to go though a foreclosure, the buyer picks up a property at a discount, and the lender avoids taking on the burden of unloading the property.
A short sale may impact the seller's credit (see short sale vs. foreclosure). Also, lenders may only agree to a short sale if the seller is several payments behind and has received a default notice.