Tenants who learn that their landlords are in default on the mortgage (or already in foreclosure) are often confused about who is entitled to the rent money. Residents are likely to hear demands from many quarters—the desperate owner, a management company, or a bank.
It's important to know who is—and who isn't—entitled to the rent check and who is obligated to maintain the rental during this period of time.
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 Freddic Mac 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. But as far as the tenants are concerned, the bottom line is the same: With proper notice, they will be expected to pay the rent to the bank.
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 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 when it comes to safe and secure rental housing, because in every state but Arkansas, landlords must maintain fit and habitable rental housing. 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.
But here is where things can get truly 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 are not 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 is not 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.
If you need to notify the landlord and bank of needed repairs to your rental, be as specific as possible. Nolo's eForm Tenant's Notice of Needed Repairs provides the format and instructions to make sure your demand is correct.