Tax Lien Investing: What You Need To Know
Miranda Crace7-minute read
June 01, 2023
Have you considered investing in real estate? Tax lien investing is an indirect way of real estate investing. Rather than buying properties, you’re buying tax lien certificates with the hope of a return later. In this article, we’re laying out everything you need to know about tax lien investing, including the pros and cons and how to get started.
What Is A Tax Lien?
A tax lien is a legal claim against a property that occurs when the property’s owner fails to pay government-owed taxes. Tax liens are placed by the city or county in which the property is located, and act as a legal claim to the property for the unpaid amount. Properties with a tax lien on them can’t be sold or refinanced until the taxes are paid and the lien is removed.
After a tax lien is placed on a property, the local government issues a tax lien certificate that details the amount owed. These certificates are then auctioned off to investors. The amount that a tax lien might sell for depends on the specifics of the property.
Tax Liens Vs. Mortgage Liens
It’s important to clarify that tax liens are different from mortgage liens. A mortgage lien gives your lender a claim to your property until you pay back your mortgage loan. A tax lien, on the other hand, gives the government or owner of the tax lien certificate claim to the property.
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What Is Tax Lien Investing?
Tax lien investing is a type of real estate investing where individuals purchase tax lien certificates. These certificates are created when local governments place liens on people’s property due to unpaid taxes. There are 28 states that currently allow for the sale of tax lien certificates. Since there are approximately $21 billion of delinquent property taxes each year, it’s a booming business.
How Does Tax Lien Investing Work?
Wondering how to invest in tax liens? Tax lien investing is quite different from the traditional stock market or bond investing, so it’s important to understand what you’re getting yourself into. Here’s how the process of tax lien investing works.
1. The Local Municipality Creates A Tax Lien Certificate
Local governments charge property taxes to help fund government programs and services. If a homeowner fails to pay their property tax bill, the local government places a lien and creates a tax lien certificate. This certificate includes information such as the amount of tax due, as well as any interest or penalties.
If the property owner still doesn’t pay their tax bill (with interest), then the government has the right to foreclose on the home.
2. The Tax Lien Certificate Is Put Up For Auction
In 28 states, the government can sell tax lien certificates to private investors, which allows them to recoup their losses more quickly. This sale usually happens at a tax lien auction, where the certificate goes to the best bidder.
3. Investors Bid On The Tax Lien Certificate
Depending on the auction, bids may be based on either the cash amount someone is willing to pay for the certificate or the interest rate they’re willing to accept. In the case of cash offers, a certificate goes to the highest bidder. In the case of interest rate, it goes to the lowest bidder.
Keep in mind that the lower the interest rate you bid on a tax lien certificate, the lower the profit you could potentially receive. Bidding wars on tax liens can drive the interest rate – and therefore the profit – down.
4. Winning Investor Takes Control Of The Tax Lien Certificate
The winning bidder of a tax lien auction takes ownership of the tax lien certificate. This doesn’t technically give them ownership of the property. But it gives them the right to take ownership of the property through foreclosure or be paid back when the homeowner eventually pays their tax bill.
5. Investor Pays The Amount Of Taxes Owed
When you win a tax lien auction, you’re immediately responsible for paying the tax bill, including any interest or fees owed. Then, the homeowner has a certain amount of time before the redemption period deadline, by which time they must pay the new investor or risk foreclosure.
6. Repayment Or Foreclosure
When you purchase a tax lien certificate, there are two potential outcomes: either the homeowner will pay their property taxes, or they won’t. If the homeowner pays their property taxes, then you make back your initial investment, plus the interest rate you bid at the auction.
If the homeowner doesn’t pay their property taxes, then you have the right to begin the foreclosure process. Depending on the state, there may be an expiration date which requires you to initiate foreclosure within a certain amount of time after buying the tax lien. If you fail to take action, you may lose your right to collect your investment.
It’s important to note that it’s quite rare for the situation to get that far. The majority of homeowners pay their tax bills before the foreclosure process begins.
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The Pros And Cons Of Investing In Tax Liens
Tax lien investing can have its advantages, but it’s also important to be aware of the downsides. Let’s take a look at the pros and cons of tax lien investing to help you decide if it’s right for you.
The Pros Of Tax Lien Investing
Interest Rate Returns
The profit from tax lien investing comes from the interest that homeowners pay when they pay their delinquent tax bills. Interest rates can vary depending on where you live. For example, tax liens have a maximum interest rate of 18% in Florida and a fixed rate of 12% in Alabama. Keep in mind that if you bid down the interest rate, the rate on the lien isn’t exactly what you’ll receive.
Initial Investment Can Be Passive
Tax lien investing requires a significant amount of research upfront. Investors may be able to passively invest in tax liens without having to attend the auction or worry about any of the other intricacies. For a more passive investing experience, you can contact a National Tax Lien Association professional or fund manager.
The Cons Of Tax Lien Investing
Before you dive into tax lien investing, it’s important to understand the downsides. This type of investment has a large amount of risk. It’s recommended that only professional or experienced investors take on this kind of investment.
Required Research And Preparation
There’s a lot of upfront work that goes into tax lien investing. To get started, you must be familiar with property in your area, and do substantial research into the specific property with a tax lien on it. You must also research any other potential liens that would impact your ability to claim the property.
In addition to the upfront work, there’s also a lot to consider once you purchase a tax lien certificate. First, you must be aware of all deadlines, as well as initiate communication with the homeowner to get your money. If the homeowner doesn’t pay their tax bill, you’re responsible for initiating the foreclosure, which requires time and expertise.
It’s important to know that tax lien certificates have an expiration date. If you don’t receive your payment or foreclose on the home before a certain deadline, then you lose your right to do so.
It’s important to research the condition of a property before bidding on a tax lien certificate. If you end up having to foreclose on the home, you become the owner. The cost necessary to rehabilitate or sell the property could eat into your profits.
It sometimes is hard for individuals to find profitable tax liens because commercial institutions like banks and hedge funds are easily able to outbid individual investors. You may have to be patient and withstand a couple of failed attempts before you're able to successfully invest in a tax lien certificate.
How Can I Start Investing In Tax Liens?
If you’re ready to get started investing in tax liens, here are some tips that can help you be successful.
Decide On A Type Of Property
The first place to start is to determine what type of property you want to bid on. Are you interested in single-family homes or commercial properties? It’s important to do your research ahead of time.
Contact Your Tax Revenue Office
Once you’ve decided to enter a tax lien auction, contact your local tax revenue office. They’ll have information on local tax lien auctions and can tell you what’s required to participate. Keep in mind that not all states allow for the sale of tax lien certificates, so this may not be an option near you.
Research Each Potential Property
The most important step of the process is researching each property. Before you bid on a tax lien certificate, it’s important to understand the property value and current state of the property. Make sure you know all of the payment requirements and deadlines before bidding. Finally, make sure you fully understand what’s involved in the foreclosure process since it may come to that.
How To Buy A House With A Tax Lien
Curious about how buying a house with a tax lien works? If you’re paying cash for the home, you’re not required to resolve the lien before the sale is complete. Just keep in mind that you’ll inherit the lien and all the responsibilities that come along with it if you go this route.
In most cases, home buyers who are financing their home purchase can arrange to have the seller pay off the tax lien with the proceeds from the house. However, there are some potential complications to be aware of before you buy a house with a tax lien.
Tax Liens And The Mortgage Process
If you’re not able to negotiate to have the seller pay off the tax lien after the sale, or if the tax lien is more than the seller will receive in proceeds from the sale, home buyers can run into issues with financing. In some cases, a lender might even stop the mortgage approval process after discovering the lien.
Tax Liens And Title Insurance
Home buyers may also have trouble getting title insurance when purchasing a house with a tax lien. Without title insurance, the home buyer is responsible for all existing liens on the home, which could potentially include more than just the tax lien in question.
The Bottom Line
Tax lien investing is an indirect way of investing in real estate by purchasing tax lien certificates for unpaid property taxes. These certificates become profitable in the likely scenario that the homeowner pays their tax bill. While they can offer a generous return, it’s important to understand the significant risk included in this type of investing. If you’re interested in other kinds of real estate investing, be sure to check out this guide to learn about the tax benefits of real estate investing.
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