About ten years ago we frequently learned one of our owners was in default. The owner was collecting the rent proceeds and not paying their mortgage payment. Fortunately, this issue is not as common today. Occasionally it does still occur and the problems created caused us to take action. It is recommended that a well written property management agreement (PMA) addresses the issue of foreclosure. The suggested clause to be created in a PMA is the owner's duty to avoid foreclosure.
There are many dilemmas associated with foreclosure, The effects of foreclosure in a rental are wide-ranging. Unfortunately, foreclosure places all parties (the owner, their tenants, and the property manager) at risk. What should be the response to a notice of foreclosure on a rental property? Should it be to declare the PMA to be in default? Significantly, a default may allow the manager to cancel the PMA but it will do nothing for the tenant. In fact, foreclosure presents a very complicated situation for tenants.
There are several angles to this issue. Assuming a tenant makes their rent payment on time every month the owner can choose how to use the funds. What if the owner has a mortgage obligation on the rental? Nothing stops the owner from electing to use the rent funds for other needs. The owner has the freedom to choose to not make their mortgage payments. The foreclosure process can take as long as 18 to 24 months to complete. This period of time provides a comfort to the owner that things will get better and they will get caught up on their back payments.
The tenant will not be aware of any problems with the mortgage holder until a Notice of Default is delivered to the home. For a tenant this notice will set off the alarm bells. Interestingly, some tenants who have receive a posted Notice of Default at their rental think they are no longer obligated to make rent payments.
A property manager needs to remind the tenant of their separate contracted obligation to make their rent payments. Technically, the tenant must make payments per the term of the lease for the entire length of the lease. There are usually no clauses in a lease that excuse a tenant from making rent payments if it is found the owner is not paying their mortgage.
The issue of allowing your rental to fall into foreclosure is an ethical one for an owner. Whether or not it is ethical to collect the rent and not make the mortgage payment?
Outside of the obvious contract violation occurring with the owner's mortgage, there is not a law prohibiting this decision. Should the ethical landlord provide disclosure of their decision and actions to their tenant? It really is ethical that the tenant be made aware before a posting of foreclosure hits their front door. It is also important that the tenant understand that at some point they may have to vacate the home on somebody else's terms. Unfortunately, disclosure to the tenant is more than rare. Usually the owner does not want the tenant to know about the default as it might disrupt the tenant's payment of rent.
Depending on the locale and who ends up the owner of the property, the tenant is likely protected under their existing lease terms. It is not unusual for the new owners of a foreclosed property to make an offer for the tenants to vacate their lease. Or the new owner will strictly enforce all provisions of the lease. The message to the tenant is very loud and clear. "We do not want you living here so please leave."
Over 10 years ago we added language to our PMA to address owners and foreclosure.
DUTY TO AVOID FORECLOSURE: OWNER certifies that all mortgage obligations, property taxes, association fees, (and/or any other obligations which could lead to a foreclosure action against the property) are current at this time and further agrees to keep them current and paid in full as required. OWNER acknowledges that it is a fundamental obligation of a Landlord to provide their Tenant Quiet Enjoyment of the rented premises. Anything that jeopardizes Tenant’s right to occupancy, such as failure to service mortgage or discharge any lien, places that right in jeopardy. Therefore, to continue to collect rent and /or fail to notify Tenant of impending foreclosure would be a breach of that duty.
Our obligation and procedure when we receive notice of a foreclosure filing:
The Duty To Avoid Foreclosure clause gets this issue out on the table prior to taking over a management. It forces owners to acknowledge that collecting the rent, while not making the mortgage payments or disclosing this decision, is a violation of their PMA. It is one of the few tenant protections in our agreement that is not directly derived from law. This language is the result of combining our commitment to ethics with protection of tenant rights. We also want our owners to share the priority of ethical treatment to their tenants.
Ready to rent your home or property? Let's schedule a time to talk. The experts at WILMOTH Group have more than 25 years of experience in property management in the Indianapolis area.