I've read from several reliable-looking sources that if a foreclosed house goes up for auction, the bidding usually starts at the outstanding amount of the loan (plus fees, etc.): Example Money Talks, Consumer Affairs, Biggerpockets.
My question is: Why? Under what logical set of assumptions should the starting bid have anything to do with the outstanding amount of the loan?
I know a lot about math and econ theory and nothing about mortgages. So I feel like I'm just missing a key assumption here. But without that key assumption, the idea of starting the bidding at the outstanding loan amount makes no sense.
Suppose someone bought a house for $300,000. After time, the fair market value of the house dips to $250,000, and the buyer owes $100,000 on the mortgage. They stop making payments, so the house goes up for a foreclosure auction.
In that situation, why on earth would the bank start the bidding at $100K? It has nothing to do with the expected market value of the house. A bidder might get really lucky and walk away with the house for $101K even though it's worth $250K. More likely, if the marketplace is efficient, the bidders will end up bidding the value to about $250K anyway. But why bother starting the bidding at $100K? The only number that seems to make sense for the bank to start the bidding at, is the estimated free market value of the house (or maybe a little less, just so the bank can be sure someone bids). Anything else seems completely arbitrary.
I feel like maybe these articles are leaving out some key fact, like: "If you bid the outstanding loan amount, you win the right to live in the house, but you don't own the whole house; the previous owner still retains the equity that they had before they got evicted." Now in that completely hypothetical scenario that I just made up, it actually would make sense for the free market bid to be $100K -- however, I'm pretty sure that's not what happens in a foreclosure auction.