Tenants Enjoy Protections When Landlord/Homeowner Loses Property to Foreclosure

These days, foreclosures are commonplace. Our natinal economy is experiencing the hangover following years of a credit party reminiscient of a fraternity blow-out. A recent magazine article quoted the CEO of mega-homebuilder Toll Brothers spreading the blame:

“What cracked the market was not just our greed but the greed of our buyers.”

Irrespective of the cause, thousands of tenants have received a nasty and unexpected surprise -- news that the home they are occupying has been foreclosed. Even worse is that in most instances the new owner -- often the mortgage lender -- has plans for the property that don't include continuing the lease. Frequently, the tenant has been faithfully paying rent to the landlord, and wasn't even aware that the property was subject to foreclosure. Imagine the financial disaster that can accompany being suddenly and unexpectedly displaced from a comfortable rental home...

Fortunately, Texas law provides some relief for an unwitting tenant of a foreclosed property.

First, the notice period required before a landlord may file an eviction suit is extended from 72 hours to 30 days (provided the tenant was in compliance with the lease at or near the time of foreclosure). See Texas Proeprty Code Section 24.005.

Second, if the previous owner's interest in the premises is terminated by sale, assignment, death, appointment of a receiver, bankruptcy, or otherwise, the new owner (other than the foreclosing bank, itself) is liable for the return of security deposits. See Texas Property Code Section Sec. 92.105.

I have heard of instances where new owners of properties acquired through foreclosure or trustee's sale have actually offered to pay a pre-existing tenant to vacate the property promptly and peaceably. Such a payment can make sense for both the new and reluctant owner/landlord and the innocent tenant. The new owner obtains certainty and finality concerning possession of the property -- all without incurring attorneys' fees associated with an eviction proceeding. Meanwhile, the tenant receives a quick infusion of cash to help offset moving and related expenses.

If you are either the new owner of a tenant-occupied property, or a tenant in a rental property whose ownership has changed through foreclosure, you should consider consulting an experienced real estate attorney who can explain your rights and responsibilities.

MORTGAGE GLOSSARY

Mortgage: A real estate debt instrument under which the borrower gives the lender a lien on the property as collateral for repayment.

Prime mortgage: A real estate loan in which the borrower meets the underwriting standards set by federal home loan agencies Fannie Mae and Freddie Mac. Fannie and Freddie buy mortgages from lenders to sell as bundled mortgage bonds, but the lenders have to make sure their mortgages meet the federal underwriting guidelines to be eligible. A typical prime mortgage covers a maximum of 80 percent of the value of the house, and housing costs should absorb no more than 28 percent of the buyer's gross income.

Subprime mortgage: Type of loan aimed at giving more buyers a chance to own a home, particularly buyers with less money for a down payment, less income and checkered credit histories. In the last decade, lots of subprime mortgages were written with little or no down payments, low but adjustable interest rates and little credit scrutiny. Once the adjustable rates reset, subprime mortgages required substantially higher interest rates than prime mortgages, which made them attractive to investors who bought bundles of these mortgages from lenders.

Alt-A mortgage: Short for "alternative-A." These loans form a class of mortgage between prime and subprime. Typically, they involve buyers who would be considered prime but who have little documentation of their creditworthiness or are seeking jumbo loans beyond the limits accepted by Fannie Mae and Freddie Mac ($417,000 until Congress raised the limit earlier this year).

ARM: An adjustable-rate mortgage. Such mortgages usually have a low introductory interest rate that resets after three to five years at a higher rate.

Statement loans: When a buyer didn't want to bother with documenting income and credit history, some lenders offered statement loans that required nothing more than the buyer's word that he was good for the loan.

Piggybacks: Two loans taken out at once on the same property. A typical prime mortgage requires a 20 percent down payment. Buyers who don't have that amount are generally required to purchase private mortgage insurance, which covers the lender in case of default. To avoid PMI, many borrowers took out two mortgages at once – one for 80 percent of the value of the house and a shorter-term mortgage (typically an ARM) to cover the down payment. Both mortgages were tax-deductible, which made piggybacks more attractive to buyers than PMI. (PMI became tax-deductible in 2007.)

Silent seconds: Second loans taken out without the knowledge of the first lender. Many borrowers who took out piggyback mortgages did so without telling the lender making the first mortgage. This compromised the lender's credit check. Since most lenders planned to sell the mortgage to Fannie Mae, Freddie Mac or an investment bank that would bundle it into a mortgage-backed security, credit scrutiny often fell by the wayside.

Neg-ams: Negative- amortization mortgages. Negative amortization means that the loan amount keeps growing as the borrower makes payments lower than what's needed to pay off the interest and principal. The loans were based on expectations that home values would keep rising so that the borrower could pay off the mortgage when the house was sold.