Banks are obligated to pay an association's assessments once they take ownership of a unit. That explains why some banks drag their feet on foreclosures. With a defaulting owner, a bank loses mortgage income. If the bank forecloses, it not only loses income, it must also pay the regular and special assessments. As a result, many banks do nothing. This leaves a delinquent owner in possession of the property and the association without income. Boards have several options for collecting delinquent assessments.
Foreclosure. One of those options is to foreclose on the delinquent owner. Once title transfers, the association's lien is extinguished. Its collection rights were also extinguished per the single action rule. If an association takes a property through foreclosure all the way to sale, one of the following will own the property:
- Third-Party Buyer. If the association forecloses and a third party buys the unit, the new owner starts paying the associations assessments as each assessment is levied but is not liable for the prior owner's unpaid assessments.
- Association as Buyer. If no one buys the unit, the association takes ownership subject to the delinquent owner's 90-day redemption rights and subject to any first mortgage that may be in place. Once the association has ownership, it can either pay the mortgage (a further drain on resources but perhaps worthwhile if the property has any equity) or refuse to pay the mortgage and invite the lender to foreclose on the unit.
Distribution of Proceeds. When an association as a junior lienholder forecloses, the senior lienholder recovers nothing from the sale proceeds. However, the senior lien remains intact and the association takes title to the property subject to the senior lien. (MTC Financial v. Nationstar Mortgage.)
Association Takes Ownership. If there are no bidders at the foreclosure sale, the association takes ownership of the property. At that point, the association can:
- Retain Ownership. This requires making payments on any outstanding senior liens as well as taxes. This allows the association to put a renter in the property. Whether this is a viable option or not depends on the economics involved--can the association rent the unit for enough to cover the mortgage payments? In addition, the board need to remember to insure the property and pay property taxes.
- Sell the Property. The ability to sell will depend on whether there is any equity in the property since senior liens must be satisfied (unless the lien-holders agree to a short sale).
- Transfer to Bank. The association can transfer ownership to the senior lien-holder by means of a deed in lieu of foreclosure. Whether the bank will accept the deed depend on internal bank policies. Many banks will not accept a deed because of possible title insurance issues. Instead, they prefer to foreclose on the property.
- Allow Bank Foreclosure. Another option is to hold the property but not pay any monies to the senior lien holders and allow them to foreclose on the property. If the unit sits empty until the bank forecloses, the association continues to lose the income it would normally receive from a dues-paying owner. If the association puts a renter in the unit and collects rent without making payments to the bank, it risks an action for rent skimming.
Possible Rent Skimming. If the association takes ownership of an owner's unit and decides to not pay the senior mortgage, the lender may still fail or refuse to take action. Too many banks are delaying foreclosures because they don't want the property on their books nor do they want to pay the association's monthly assessments. As a result, they sit on their hands and do nothing. If that happens, some associations put a renter in the unit to supplement the association's budget until such time as the bank forecloses or takes a deed in lieu of foreclosure. Boards should be aware that this may violate Civil Code § 890, otherwise known as "rent skimming" which could result in liability for actual damages, attorneys' fees and costs. There is disagreement in the legal community whether this statute applies to associations. Accordingly, boards should consult legal counsel before choosing this course of action.
Impact on Association's Credit? If an association takes ownership and the bank subsequently forecloses, the foreclosure will not negatively impact the association's credit. The bank's loan is in the prior owner's name and the bank is foreclosing on the prior owner's mortgage, not the association's. The prior owner's credit is harmed, not the association's. Even if the association's credit were somehow affected, it would have little or no impact. Associations normally do not borrow money for consumer goods or to buy property. Typically, the only time they borrow is for major repairs. When that is done, the loan is secured by a special assessment approved by the membership.
Recommendation. Regardless of the course an association follows, it may have bad debt that will ultimately need to be written off. In addition to budgeting for bad debt and recording liens as quickly as possible to protect the association's position, boards should record a "Request for Notice" in the event the bank forecloses and a third party buys the unit.
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