Spend the rents generated by a property in foreclosure and you may have invited big trouble even if bankruptcy is in your future.
The borrower in the typical real estate transaction pledged the rental income and other proceeds of the encumbered property to the lender along with the real estate, as security for the obligation to repay the loan. Those rents are “cash collateral” in which the lender has a legal interest.
The borrower may have a fiduciary relationship to the lender with respect to those rents. Failure to pay them over to the lender may be a species of fraud, potentially non dischargeable in bankruptcy.
I’ve seen a rash of clients in the past couple of weeks who have rental houses that are now, or soon will be, in foreclosure. Once a notice of default is recorded, starting the foreclosure process, the lender won’t accept payments unless the borrower can tender the entire amount necessary to cure the default.
So, the borrower is collecting rent from the tenants but the lender isn’t accepting payment of those rents if not sufficient to cure. The borrower is in possession of a hot potato.
My advice to such clients is to set up a bank account and deposit any rent net of the costs of preserving the property to this separate account which contains only the cash collateral that belongs to the lender in question.
I haven’t yet had to figure out if/when the lender will accept payment of those funds, but that’s a far better problem to have than a nondischargeability action against the borrower for fraudulent misuse of the lender’s security.
If this fact pattern mirrors your situation, get an attorney involved in making sure that you don’t lose more than the property to foreclosure.
