When a landlord defaults on the mortgage of a rental property, or when the rental is already in foreclosure, tenants often discover—many times without warning—that their rented house or apartment is now owned by a bank, which wants them out.
If you're a renter who's discovered that your rental property is facing or is under foreclosure, here's some guidance on how to navigate the situation.
When an owner defaults on a mortgage, it means that they have failed to comply with the terms of the promissory note or mortgage (or deed of trust) they signed when they took out the loan to purchase the property. Most often, the owner goes into default when they don't make the required monthly payments. A default occurs as soon as a payment is missed.
In general, when the owner fails to make the payments on their mortgage for more than 120 days, the lender can begin the foreclosure process. This means that the lender can use state procedures to sell the house to repay the debt. (Foreclosure procedures vary from state to state.)
When the foreclosure is complete, there's a new owner of the property—most often a bank. The bank can hold onto the property or sell it. Many banks will pay a servicing company to handle the property post-foreclosure. But don't expect active property management—these companies are focused on financial matters, not mundane things like maintenance.
Lending banks (the mortgage holders) typically attach a rider, or special agreement, to the mortgage or deed of trust documents when a buyer intends to use the building as a rental. This rider, called a 1-4 Family Rider (Assignment of Rents), is used by lenders in every state for one- to four-unit investment properties and two- to four-unit principal residences. Its main purpose is to give the lender the right to receive the rent when the buyer has defaulted on the mortgage. (You can get a copy of the 1-4 Family Rider from the Fannie Mae website.)
To understand how the rider works, think like a banker for a minute. The property is generating income and the buyer is falling behind on the mortgage. In order to cut its losses as quickly and as thoroughly as possible, the lender wants to get its hands on the rent.
Once the lender gives the owner a written notice of default, lenders in most states have the right to receive the rent directly from the tenants. Lenders have to give written notice to the tenants, and they typically do so by letter, posted notice on the property, or in person.
The 1-4 Family Rider is a standard form that's used for small properties (four or fewer rental units). Banks and buyers use a standard form because they assume that the relatively small size of the deal doesn't merit lengthy negotiations between the parties.
Larger properties almost always have the same sort of arrangement—if the owner falls behind on the mortgage payments, the lender gets the right to receive the rent. Usually, these arrangements are negotiated by the banks and the buyers' lawyers and might include unique provisions that are hammered out by the parties.
As far as tenants are concerned, though, when it comes to paying rent, the bottom line is the same: With proper notice, they will be expected to pay the rent to the bank.
Before President Obama signed the "Protecting Tenants at Foreclosure Act of 2009," most renters lost their leases upon foreclosure. But this legislation provided that leases would survive a foreclosure. The tenant could stay at least until the end of the lease, and month-to-month tenants would be entitled to 90 days' notice before having to move out.
An exception was carved out for the buyer who intends to live on the property—this buyer may terminate a lease with 90 days' notice. Importantly, the law provides that any state legislation that is more generous to tenants will not be preempted by the federal law. These protections apply to Section 8 tenants, too.
The federal law came to an end on December 31, 2014, but was restored on June 23, 2018, as part of the Economic Growth, Regulatory Relief, and Consumer Protection Act. Also, many states and municipalities continue to provide the same protection.
Local laws may come into play, too. Tenants who live in states or cities with "just cause" eviction protection as part of a rent control law are also protected from terminations at the hands of an acquiring bank or new owner. These tenants can rely on the law's list of allowable reasons for termination. Because a change of ownership, without more, does not justify a termination, the fact that the change occurred through foreclosure will not justify a termination.
During the default and foreclosure process, even though the bank is receiving the rent payments, all other rights and responsibilities that the owner/landlord has with respect to the tenants remain in place. Until the bank actually forecloses, the owner is still the owner. This leads to problems if the tenants need maintenance or repairs done on the rental unit.
Landlords who are in foreclosure are often unwilling to make repairs: Without a source of income from the rental property, most owners will be unable (or unwilling) to maintain it. For the tenant, however, the owner's disillusionment is beside the point, because in every state, landlords must maintain fit and habitable rental housing. So how does a tenant enforce this right against a demoralized (and possibly broke) owner?
According to the Family Rider, the lender must apply the rent money to property management costs, including maintenance, before it applies the money to the unpaid mortgage. But the Rider explicitly does not obligate the lender to assume the maintenance duties of the owner. Unless there's a specific local or state law to the contrary, the lender's right to receive rent money doesn't turn that lender into the landlord for purposes of maintaining the property.
If conditions seriously deteriorate to the point where the home is not fit to live in, tenants might find themselves stuck between an owner who has no ability to take care of business, and a lender who has no obligation to do so.
Self-help remedies are tricky. Tenants might need to avail themselves of a tenant's "self-help" remedy, such as rent withholding and repair-and-deduct (note that only some states give these remedies to tenants).
But here is where things get tricky: Rent withholding and repair-and-deduct work because they pressure owners to take care of repairs so that they can receive the rent. But banks aren't familiar with property management and maintenance, and they have no legal obligation to maintain the property (the owner retains that duty). Not paying the bank isn't likely to result in prompt attention to that leaking roof or broken water heater—it's more likely to result in a notice to vacate or, particularly in situations where tenants survive the foreclosure, continued inattention until conditions deteriorate further.
In many cities, housing and health departments are charged with responding to unsafe and unsanitary conditions in rental housing. They typically have powers that range from ordering the owners to take care of business (under threat of contempt of court), to taking over the property altogether and running it until they've fixed the problems (and charging the owner for the privilege).
Although these government agencies can, and should, still do their jobs, their intervention might be ineffective. The agencies will be dealing with an owner who has no resources to contribute (and who might even be impossible to locate), and a bank who has no legal duty to step up. Results will differ when the government takes over because the efficiency of local and state agencies varies tremendously.
New owners might want to terminate existing tenants because they believe that vacant properties are easier to sell. Common sense suggests otherwise. In many situations a building full of stable, rent-paying tenants will be more valuable (and command a higher price) than an empty building. Emptied buildings are also prone to vandalism and other deterioration—after all, no one is on site to monitor their condition. When entire neighborhoods become a wasteland of empty foreclosed multifamily buildings, their value drops even further. It's hard to understand why new owners choose to pay lawyers to start eviction procedures instead of paying a modest fee to a management company to collect rent and manage the property while they wait to sell.
Cash for keys. To encourage tenants to leave quickly and save on the court costs associated with an eviction, banks often offer tenants a cash payout in exchange for their rapid departure. Thinking that they have little choice, many tenants—even Section 8, protected tenants—take the deal. It doesn't help them much as they join the swelling ranks of newly displaced tenants (and former homeowners) who are competing to find an affordable new rental.
Thanks to the legislation explained above, most tenants with leases will keep their leases, and month-to-month tenants will have at least 90 days to relocate. Tenants with leases have no legal recourse against their former landlords, because they are in the same position with the new owner as they were with the old: The lease survives and ends as it would had there been no foreclosure. Similarly, month-to-month tenants always know that they can be terminated with proper notice.
However, a lease-holding tenant whose rental has been bought by a buyer who wants to move in to the property might end up less fortunate than before the foreclosure—these tenants might lose their lease with the state-required notice, a result that probably would not have happened had the owner simply sold the property to a buyer who intended to occupy the property. (Normally, the new owner has to wait until the lease ends, absent a lease clause providing for termination upon sale, though such clauses might not be legal in all situations.)
After signing a lease, the landlord is legally bound to deliver the rental for the entire lease term. In legalese, this duty is known as the "covenant of quiet enjoyment." A landlord who defaults on a mortgage, which sets in motion the loss of the lease, violates this covenant, and the tenant can sue for the damages it causes.
Small claims court is a perfect place to bring such a lawsuit. The tenant can sue the original landlord for moving and apartment-searching costs, application fees, and the difference, if any, between the new rent for a comparable rental and the rent under the old lease. Though the former owner probably isn't flush with money, the awards in these cases won't be very much, and the court judgment and award will stay on the books for many years. A persistent tenant can probably collect what's owed eventually.
For more information on suing a landlord in small claims court, see Everybody's Guide to Small Claims Court or Everybody's Guide to Small Claims Court in California.