By Nancy T. Polomis, Esq. and David G. Hellmuth, Esq.
It’s difficult to pick up a newspaper or magazine, to surf the Internet or listen to the radio these days without hearing of the plight of homeowners facing foreclosure in these declining economic conditions. While putting a “face” on those being foreclosed upon certainly personalizes the issue—and sometimes makes for “better TV”—there are also other silent, faceless unintended victims of the mortgage industry meltdown: homeowners associations.
Homeowners associations rely on homeowners’ timely payment of assessments to pay operating expenses. When a homeowner has difficulty paying his monthly bills, he often lets his obligations to the association “slide.” If a homeowner’s financial straits are so dire that he stops making his mortgage payments, chances are, he also stops paying his association assessments—if he hadn’t already stopped paying them. If his lender forecloses its mortgage, the homeowner isn’t the only party affected by the foreclosure. Unfortunately, community associations can become unintended victims of mortgage foreclosures.
Liens for association dues are generally subordinate to first mortgage liens. If a first mortgage lender forecloses its mortgage, the association’s lien is extinguished, either in whole or in part, by that mortgage foreclosure. For those associations not governed by the Minnesota Common Interest Ownership Act (MCIOA), the lien for all unpaid assessments is extinguished. For associations governed by MCIOA, the association retains a “superlien” for assessments accruing, without acceleration, during the six months prior to the expiration of the owner’s redemption period. This “superlien” provision is not likely to make the association whole, but it will lessen the “sting” of the loss suffered by the association as a result of the mortgage foreclosure. However, the association may have to wait quite a while to receive the funds from the foreclosing lender; most lenders simply pay their assessment liabilities from the proceeds of the closing upon their subsequent sale of the property—which may not occur for several months after the foreclosure is complete. Meanwhile, the association’s obligations to pay expenses and maintain its grounds remain. Without sufficient funds, however, routine maintenance may suffer and capital improvements may get delayed. Such delays may have adverse effects on the appearance of the community as a whole which, of course, affects resale values. Thus, the association and all its members suffer the adverse effects of one member’s mortgage foreclosure.
Further, at the end of the day, the loss arising from the unpaid assessments is then “absorbed” by the association, and spread among the remaining units. Thus, not only does the association’s lien get extinguished, but the other homeowners in the community must make up the shortfall resulting from the foreclosure—and pay more to ensure adequate maintenance and timely completion of capital improvements. The inevitable increase in the next year’s assessments can stretch homeowners’ budgets to the breaking point—which can result in more mortgage defaults and more foreclosures, thus bringing the foreclosure cycle full circle.
What can an association do?
The key to an association’s financial survival is addressing delinquencies early. While early intervention may not completely avoid a loss as a result of a first mortgage foreclosure, it can minimize that loss. Consider, for example, an association that adopts the policy that any account 60 days’ delinquent is referred for collection. Chances are, that aggressive collection practice has two effects: (1) more funds are collected, since it is generally easier to write a check for $500 (two months’ dues) than one for $1,000 (four months’ dues), and (2) other homeowners quickly learn that the association’s invoice is not the one to put at the bottom of the bill pile!
If early intervention does not result in payment, then more serious measures must be employed. If, after evaluating the value of the property and the liens against it, it makes economic sense for the association to foreclose its lien, it should do so as quickly as possible. Beating the mortgage lender to foreclosure can result in payment from the homeowner or from a junior mortgage holder (e.g., the home equity mortgage holder or line of credit lender), whose lien would be wiped out by the association’s foreclosure.
Sometimes, however, foreclosure of the association’s lien isn’t the best course of action for the association. Fortunately, enforcement of the lien is not the association’s only option. The obligation to pay association dues not only creates a lien against each unit, but is also the personal obligation of each homeowner. Therefore, even if an association loses its lien against the property as a result of mortgage foreclosure or foreclosure of the association’s lien just doesn’t make economic sense, the association can pursue a judgment against the delinquent homeowner. The association can then collect on that judgment via wage garnishment, bank levy or other collection measures. Even if assets to satisfy the judgment are not immediately available, the association’s judgment remains in place for a period of ten years, so collection in the future is also a possibility.
Difficult as it may be to tackle the problems of unpaid assessments and mortgage foreclosures, “sticking one’s head in the sand” is simply not an option for associations. An association’s board of directors owes an obligation to all the association’s members to pursue collection of all assessments diligently. With the current real estate market and economic conditions, enforcement of the association’s lien may not be the easy answer it once was, but that does not leave associations without collection options.
Ultimately, the effects of the record-setting pace of mortgage foreclosures are far-reaching. Individual homeowners see their dream of homeownership turn into a nightmare of homelessness. Homeowners associations see their income stream interrupted, leaving maintenance incomplete and improvements delayed. Other homeowners see their own assessment increase to make up shortfalls, and their own property values fall as maintenance waits and foreclosed properties sit vacant. Indeed, today’s foreclosures have many victims—some of whom never missed a mortgage payment.
Nancy T. Polomis is a partner in the law firm of Hellmuth & Johnson, PLLC, and a graduate of the William Mitchell College of Law.
David G. Hellmuth is a partner and founding member of the law firm Hellmuth & Johnson, PLLC. He obtained his juris doctorate degree and is a cum laude graduate of the William Mitchell College of Law.