Dealing with a Foreclosed Rental Property
As a property manager, or a landlord, having a rental home foreclosed upon can be a real nightmare. The Protecting Tenants at Foreclosure Act expired 12/31/14. So we are back to the old rules. If a foreclosure takes place today then the lease is no longer valid (the mortgage is a superior claim to the property than any lease). Typically the mortgage company that “bought” the property at the foreclosure sale is going to evict any current resident, or offer a “cash for keys” deal, in order to make the property vacant so the lender can sell it to recover some or all of the debt. If the current resident is a tenant, this tenant may be losing their HOME due to no fault of their own.
Issues For the Landlord – when your payments are in arrears, and you know you are at risk for losing the property to foreclosure, you need to deal with this issue and your tenant. If your loan is in arrears, and you re-rent the property to a new tenant without disclosing the problem, you run the risk of the tenant filing a fraud complaint against you – you knew of a likely foreclosure and didn’t disclose it which lead to the loss of the tenant’s home. Whether you re-rent a property where the loan is in default, or fail to inform a current tenant of a pending foreclosure, the owner/landlord is at risk for a tenant suing for having lost their home due to the landlord’s actions by permitting the foreclosure. A lawsuit where one of the parties lost their home, and potentially much more thru the eviction process, can be very ugly and very expensive.
Issues for the Property Manager – The first challenge is finding out that the loan is in default. We have seen several properties foreclosed upon between 2008 and today and it was a very rare circumstance where the owner informed us that their loan was in arrears and likely to be foreclosed. Normally we find out from the tenant. Often the lender will send a letter to the property address announcing that the loan is in default and scheduled for a foreclosure in the coming months. That is when the tenant calls us in a panic about what to do since they are about to lose their home. However, until the transfer of title thru the foreclosure (or deed in lieu), the lease is still in effect. And, until the foreclosure or some other cancellation of the management agreement, the property manager is still obligated to enforce the lease.
Our technique – The first issue is to address this in the management agreement. In the GAR Management Agreement, and in our agreement, there is a clause that authorizes the property manager to stop making disbursements to the owner once we have knowledge that the mortgage or HOA fees are in arrears until the owner can demonstrate the their payments are made current. This is important because in several instances we were not notified of the foreclosure until after the foreclosure sale had taken place, sometimes 2 or 3 months back. Now all of the rent paid by the tenant since the date of the foreclosure may need to be refunded to the tenant since the lease legally “died” when the foreclosure took place. Since the property manager has no authority to represent the new owner, the property manager has no authority to collect rent for this new owner.
Once you find out that the loan is in arrears, contact the tenant to explain the situation and considerations. Many tenants will want to cancel the lease immediately and move out. If the landlord has not agreed to that, then you need explain to the tenant the situation and their options:
1) The lease is still in effect and enforceable.
2) The rent the tenant pays to us will be held in escrow until the loan is brought current, the property is foreclosed, or the lease is terminated.
3) IF the property is foreclosed, then any rent for the days since the foreclosure will be refunded to the tenant. The security deposit would also be refunded to the tenant. The tenant is also likely to be offered a “cash for keys” deal from the mortgage company if that is the new owner. An investor/buyer may offer the tenant the opportunity to sign a new lease. (NOTE – when disbursing trust funds after a foreclosure, such as the rent and security deposit, make sure to follow your State law. In Georgia, we would send a letter to all parties announcing our intent, how we plan to disburse the funds, and give all parties 15 days to contest that disbursement if they disagree or want to make a claim against the funds. We have yet to have a lender request that we send them the rent or deposit and we have always returned the un-earned rent and deposit to the tenant – so far.)
4) IF the tenant moves out before the foreclosure, then it will be treated as a “skip” and the tenant’s deposit will be applied toward their unpaid balance. Their landlord reference would also indicate that they did not fulfill the lease. So it is easy to make the case to the tenant that they are much better offer to proceed according to item three above.
5) IF the owner informs us they were able to bring the loan current, then we get a copy of the owner’s most recent mortgage statement to verify that, then release the reserve on the property and disburse the funds due to the owner.
6) If the lease expires prior to the foreclosure, and the tenant decides to move out, then it is processed as any other move out.
7) If the lease expires prior to the foreclosure, and the tenant wants to remain in the property, then we convert the lease to a month to month agreement and add a stipulation disclosing the current situation with the loan and the potential foreclosure.
We had one occasion where the owner’s loan was in default, but the lender did not foreclose for over a year – and then the owner was able to re-negotiate and get current on the loan. In instances where the amount of the funds withheld from the tenant’s rental payments become substantial, the property manager should make a determination as to what is a reasonable amount to withhold and pay the rest to the client. In the case just mentioned above, we held 3 months of rent as a reserve and disbursed any overages to the owner until the loan was brought current.
Don’t treat the foreclosure of a rental home lightly. The landlord/borrower is not the only one to suffer here. If a tenant gets evicted from their personal home while they are current on their rental payments, consider what the damage claim may be. Financial costs for the move. The emotional pain and suffering from losing their home. The additional hardship of not getting their kids into the same school. And on and on. Landlords and property managers should do everything possible to limit liability to the tenant from a foreclosure.