What happens if a bank forecloses on my rental property?
A foreclosure is when a bank takes a property that is being used as security for a mortgage that the borrower stops paying. It is similar to when a bank repossesses a car. The bank may then sell the property and use the proceeds to cover what it is owed. If the property sells for more than the mortgage debt and allowed costs, the borrower may be able to get the remaining money back after the sale. On the other hand, if the sale price is not high enough, the borrower may still be on the hook for the remaining balance of the debt.
The foreclosure rules that protect homeowners may not be as beneficial to a rental property owner. The law treats a rental property as a business or investment rather than the borrower's primary home. The foreclosure might happen faster, and you may lose legal protections. The exact differences vary by state. One common distinction surfaces in the event that the foreclosure sale does not raise enough money to pay off the mortgage. In many states, a bank may not be able to sue you if this happens after a foreclosure on your primary residence. Those protections may not apply, however, if the foreclosure is on a rental property or second home.
Unlike a purely commercial property, a rental property often has at least one person living in it. The tenant may even have dutifully paid their rent on time with no way of knowing the landlord was behind on mortgage payments. Because of this possibility, tenants are afforded protections in a foreclosure to minimize the impact on their living situation.
What are the stages of foreclosure?
There are several stages to a foreclosure, which can take months or even years to complete.
- Payment default. When the borrower misses a payment, that is a default on the mortgage. The bank will often just charge late fees and send reminders at first. It usually takes a few months before the lender takes additional action. Your mortgage contract or local law may also specify a minimum number of missed payments before the lender can take additional steps.
- Notice of Default. A Notice of Default is a formal notice that the mortgage is past due. It is somewhat similar to a landlord sending a Pay or Quit Notice. The Notice of Default gives the borrower a deadline to bring the mortgage current or face the start of the foreclosure process. Banks often will not send this notice until the borrower has missed three or more payments.
- Notice of Trustee's Sale or Judicial Foreclosure. What happens next depends on the state. In some states, the bank can send a notice that it plans to sell the property. In addition to notifying the borrower, the bank will advertise the sale or auction to the public. In other states, the bank needs to go to court and get the judge to approve a foreclosure sale. The time for this process varies, especially when judicial approval is needed, but it usually takes at least several months.
- Trustee's sale. Most foreclosure sales happen at auction. The lender sets the opening bid based on what the borrower owes, the costs of the sale, and market conditions. At the end of the auction, the winning bidder becomes the owner of the property. If the property does not sell at auction, the bank will own the property. The bank may hold the property in its own portfolio as a rental property or attempt to make it more attractive for a future sale.
- Eviction. After the sale, the new owner generally has the right to evict the current occupants. If the borrower occupies the home, this can happen within a few days. If the home is a rental property occupied by a tenant, the tenant often has rights that prevent an immediate eviction.
What happens to my tenants in a foreclosed property?
There are two major things that your tenants need to know in a potential foreclosure — who to pay rent to and how long they can stay.
Tenants continue to pay rent to the owner of the rental property even with a foreclosure pending. After the foreclosure sale, the new buyer or the bank will be entitled to collect the rent. In some situations, the bank may have a clause in the mortgage agreement giving them the right to collect rent payments before the foreclosure sale. Tenants are entitled to at least a 120 day notice in advance of any foreclosure sale. Additionally, tenants must be given written notice of any changes to who they pay rent to.
How long a tenant can stay depends on what kind of lease they have and who buys the property. The federal Protecting Tenants at Foreclosure Act provides the following timelines, which states can extend, but not shorten:
- If the tenant has no lease, they are entitled to a 90 day notice to vacate from the time the new owner takes title to the property.
- If the tenant has a lease and the new owner does not intend to live in the property, the tenant keeps the terms of that lease. Any lease renewals or extensions of a month-to-month agreement are subject to the landlord and tenant both agreeing.
- If the new owner intends to live in the property, they can break the tenant's lease with at least a 90 day notice.
If the landlord lives on the property, the tenant still generally gets the protections of their lease. However, tenants may have difficulty in this situation because the arrangements are commonly informal, and may not have a written Lease Agreement.
If you are a landlord buying a foreclosed property with an existing tenant, you may want to agree to new terms with the tenant. You can use a Lease Amendment or an entirely new Lease Agreement. Keep in mind that the tenant may have the right to say no and keep the terms of their current lease for as long as allowed by law.
Can I modify my loan to avoid foreclosure?
Some banks may agree to modify your loan to avoid foreclosure. Modification may include lowering your interest rate or extending the loan to reduce your monthly payments. A bank's willingness to modify a mortgage generally depends on your credit, income, and other factors. While it is routine practice for a bank to approve a mortgage modification to avoid foreclosure, it is not a guarantee. In addition, as a landlord, you may not be able to rely on federal and local programs designed to help owners stay in their primary residence.
Are there alternatives to foreclosure?
If you are not able to bring your mortgage current, you may have other options. If your original lender will not modify your loan, you may be able to refinance with another lender. Another option may be to seek out a real estate partner or private investor to help resolve the debt in exchange for equity.
You may also be able to sell your home at a more favorable price than you might expect from a foreclosure sale. The benefits of selling a property before a foreclosure is finalized may include:
- Keeping more of the remaining balance after paying off the mortgage and other debts.
- Getting a better price than you would at a foreclosure sale.
- Avoiding the associated penalties, fees, credit damage, and legal costs of a foreclosure.
You might want to ask if any friends, family, or even tenants would be interested in partnering, investing, or buying the property. This may be an especially good idea if you will be discounting the sale price to ensure a fast sale and know someone may be interested.
If you are facing foreclosure and want to learn more about your legal rights or what to tell your tenants, reach out to a Rocket Lawyer On Call® attorney for affordable legal advice.
This article contains general legal information and does not contain legal advice. Rocket Lawyer is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.