Mortgage default is a messy situation for the lender, delinquent borrower and tenants that get caught in the middle. Foreclosure is the legal process that allows a lender to deny a delinquent borrower his ownership interest in real property. In the years following the housing crisis that began in 2007, millions of tenants had their basic rights as renters violated. Renters can better prepare for the future by understanding their legal rights when their landlord stops paying the mortgage.
Renters have the basic right to quiet enjoyment of the premises they occupy. This covenant of undisturbed, quiet use of real property by the tenant is implied in every rental agreement, regardless of whether the rental agreement explicitly promises it.
Failing to pay the mortgage can set in motion various consequences for the borrower and tenant, including the sale of the property through a preforeclosure or foreclosure auction; change of ownership of the property back to the lender through a deed-in-lieu of foreclosure or repossession; and reassignment of rent to the lender.
Generally, a renter cannot justify withholding rent from the landlord, even if the renter knows the landlord is not paying the mortgage. A renter may, however, withhold payment in the event the landlord fails to make repairs that affect the home's safety and habitability. Each state's landlord-tenants laws have their own rent-withholding restrictions. In California, for instance, a tenant may withhold up to an entire month's rent to cover the costs of repairing substandard defects.
A landlord's default may trigger an assignment of rent clause, allowing the lender, or a third-party acting on its behalf, to collect rent directly from the tenant. The tenant is obligated to abide by the re-assignment, but maintenance and repair issues remain the obligation of the landlord, not the lender.
In general, foreclosure alternatives such as loan modifications and preforeclosure sales, also known as short sales, are available only to borrowers who occupy the home as their primary residence. In the event a delinquent landlord attempts to evict a tenant to take ownership of the property himself, sell the property or modify the loan, the tenant may have legal recourse. Landlords must provide month-to-month tenants with the minimum statutory notice before evicting them. In general, they must honor a long-term lease until it ends and cannot evict the tenant simply because they need the home back.
Landlords, despite financial hardship, remain responsible for returning a tenant's security deposit at the end of a lease. State landlord-tenant laws have strict deadlines and requirements for withholding security deposits. A renter may sue in small claims court for the landlord withholding the security deposit, failing to deliver the home for the entire lease term or failing to comply with the covenant of quiet enjoyment. Should the home go into foreclosure, the Protecting Tenants at Foreclosure Act guarantees tenants at least 90 days' notice before the new owner can proceed with eviction.