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Tax Lien Investing: What You Need To Know

April 09, 2024 7-minute read

Author: Miranda Crace

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Have you considered investing in real estate? Tax lien investing is an indirect form of real estate investing. Rather than buy properties, you buy tax lien certificates and try to collect interest on a property owner’s unpaid taxes.

Before diving into this type of real estate investing, you need to understand what a tax lien is and how tax lien investing works. We’ll also explain how you can get started with this unique approach to real estate investing.

What Is A Tax Lien On A House?

A tax lien is a legal claim on a property to collect unpaid taxes, including any accumulated interest. A local government, typically the city or county where the property is located, places a tax lien on a property when a homeowner fails to pay their property taxes.

After a tax lien is placed on a property, the local government issues a tax lien certificate that details how much the property owner owes. If the taxes remain unpaid, the certificate can be auctioned off to investors. What an investor pays for a tax lien will vary depending on the specifics of the property.

Tax Liens Vs. Mortgage Liens

While tax liens and mortgage liens are both claims against a property, they aren’t the same things. A lender places a mortgage lien on your property until you pay back your mortgage loan. A tax lien comes from a homeowner’s failure to pay property taxes, giving the government or owner of the tax lien certificate a legal claim to the property.

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What Is Tax Lien Investing And How Does It Work?

Tax lien investing is a type of real estate investing where you purchase tax lien certificates at auctions. These certificates give investors the right to collect unpaid property taxes, interest and penalties. Investors must enforce the certificate within a certain time frame to collect what’s owed.

If you’re interested in this unique investment strategy, check if it’s allowed in your state. The sale of tax lien certificates to investors isn’t available in all states.

Tax lien investing is distinct from stock market or bond investing, so it’s important to understand what you’re getting yourself into.

Here’s how tax lien investing works:

1. The Local Municipality Creates A Tax Lien Certificate

Local governments charge property taxes to fund government programs and services. If a homeowner fails to pay their property tax bill, the local government places a lien on the property and creates a tax lien certificate. The certificate includes the amount of tax owed, interest and any penalties.

If the property owner can’t repay their tax bill, including interest and penalties, the government has the right to foreclose on the home or put the tax lien certificate up for auction.

2. The Tax Lien Certificate Is Put Up For Auction

A government can sell tax lien certificates to private investors at an in-person or online auction. The sale allows a local government to recoup their losses sooner.

3. Investors Bid On The Tax Lien Certificate

Depending on the auction, bids are based on a fixed cash amount or an interest rate. In the case of cash offers, the certificate goes to the highest bidder. In the case of an 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’ll make. Bidding wars on tax liens can drag the interest rate – and therefore profit potential – down.

4. Winning Investor Takes Control Of The Tax Lien Certificate

While the winning bidder takes ownership of the tax lien certificate, it doesn’t technically grant them ownership of the property. It gives them the right to collect when a homeowner repays their overdue tax bill. If the homeowner fails to repay what they owe, the investor may be able to take ownership of the property through foreclosure.

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. The homeowner has a certain amount of time to repay their unpaid property taxes before the redemption period deadline. If they fail to pay the investor, they risk foreclosure.

6. Repayment Or Foreclosure

When you purchase a tax lien certificate, there are two potential outcomes: either the homeowner pays their overdue property taxes, or they don’t. When a homeowner pays their property taxes, an investor makes back their initial investment plus the interest rate they bid at auction.

When a homeowner fails to repay their past due property taxes, an investor can start the preforeclosure process. Depending on the state, you may need to initiate foreclosure within a certain amount of time after buying a 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. Most homeowners pay their tax bills before the foreclosure process begins.

What To Consider When Investing In Tax Liens

Tax lien investments can be tricky. It requires a lot of time, upfront research, and a solid grasp of the foreclosure process. Let’s explore some factors you should be aware of before you put a bid on a tax lien certificate.

Interest Rate Returns

The profit from tax lien investing comes from the interest homeowners pay on their delinquent tax bills. Interest rates can vary depending on where you live. According to the National Tax Lien Association, Florida tax liens have a maximum interest rate of 18%. In Alabama, the rate is fixed at 12%. If you bid down the interest rate, the rate on the lien can reduce your overall profits.

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 the property in your area. You’ll need to do substantial research into a property with tax liens, including research on whether it has other liens that may impact your ability to claim the property.

Time-Consuming Responsibilities

There’s a lot to consider after purchasing a tax lien certificate. You must keep track of all your deadlines and initiate communication with the homeowner to start collecting. If the homeowner doesn’t pay their tax bill, you’re responsible for initiating foreclosure, which requires time and expertise.

Expiration Dates

Tax lien certificates have an expiration date. If you don’t receive your payment or foreclose on the home before your specified deadline, you’ll lose your right to recover your investment.

Neglected Properties

It’s essential to research a property’s condition before bidding on a tax lien certificate. If you end up foreclosing on the home, you become the owner. The cost to rehabilitate or sell the property may eat into your profits.

Competition

It can be difficult for investors to find profitable tax liens because commercial institutions, like banks and hedge funds, can easily outbid individual investors. You may need to exercise patience and endure a few failed attempts before you can successfully invest in a tax lien certificate.

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How To Invest In Tax Liens

Investors can buy property tax liens online or at in-person auctions. At auction, you bid on properties based on the tax lien amount or the interest rate. Your bidding strategy will depend on your goals for the properties you’re interested in.

If you’re ready to start investing in tax liens, here are some tips to help ensure success:

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? When you research the type of property you want to bid on, you know what you’re dealing with in case you have to move forward with foreclosure proceedings. For example, acquiring a commercial property through a tax lien may not make sense if you don’t have experience managing commercial properties or aren’t sure where or how to sell it quickly.

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.

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 know a property’s value and condition. And make sure you know all payment requirements and deadlines before bidding. Finally, make sure you have a full grasp of the foreclosure process because it may come to that.

How To Buy A House With A Tax Lien

If you’re paying cash for a 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 its responsibilities.

In some cases, home buyers using financing for their home purchase may be able to arrange for the seller to use a portion of the sale proceeds to pay off the tax lien. 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 can’t negotiate to have the seller pay off the tax lien after the sale or the tax lien is higher than the sale proceeds, you may run into issues with financing. In some cases, a lender will stop the mortgage approval process after discovering a 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 may include more than the tax lien.

The Bottom Line

Tax lien investing is an indirect approach to investing in real estate. It allows investors to buy tax lien certificates on properties with unpaid property taxes, with investors earning a significant profit when a homeowner pays their overdue tax bill.

While tax lien investing can offer generous returns, there’s always the risk that a homeowner can’t pay their unpaid taxes, and you’ll need to initiate the foreclosure process – which can be lengthy, expensive and time-consuming.

If you want to learn more about real estate investing – including its benefits – check out our guide on the top six tax benefits of real estate investing.

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Miranda Crace

Miranda Crace is a Senior Section Editor for the Rocket Companies, bringing a wealth of knowledge about mortgages, personal finance, real estate, and personal loans for over 10 years. Miranda is dedicated to advancing financial literacy and empowering individuals to achieve their financial and homeownership goals. She graduated from Wayne State University where she studied PR Writing, Film Production, and Film Editing. Her creative talents shine through her contributions to the popular video series "Home Lore" and "The Red Desk," which were nominated for the prestigious Shorty Awards. In her spare time, Miranda enjoys traveling, actively engages in the entrepreneurial community, and savors a perfectly brewed cup of coffee.