What Is Tax Lien Investing and What You Should Do to Become Involved With It

... Credit :
Jane Taylor in Business & Finance

Last updated: 21 January 2020, 06:52 GMT

If you want to diversify your investments, real estate is worth considering. There are different ways to invest in real estate, but if purchasing a property isn’t for you, we recommend looking into tax lien investing.

Buying a tax lien gives you the possibility to generate a steady stream of revenues. Here is what you need to know about tax liens.

What Is a Tax Lien?

What happens when a person or business fails to pay taxes? In the case of income taxes, the IRS or state tax agency will typically start garnishing a person’s wages or seize their assets.

If a person or business fails to pay property taxes, the city or county will issue a tax lien on the property. A lien is a legal claim on an asset. The purpose of a tax lien isn’t to take the property away from the owner, but rather to prevent other creditors from claiming the property.

The owner of the property can get the city or county to release the tax lien by paying the taxes and penalties they owe.

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What Is Tax Lien Investing?

If the owner of a property doesn’t payments on the tax balance owed, the city or county will eventually sell the tax lien. Selling tax liens allows local governments to get the money owed in property taxes and collection efforts can stop.

The new owner of the tax lien will collect payments from the property owner. The new owner of the tax lien purchases a tax debt from the city or county that issued the tax lien.

There is a timeline to repay the tax lien. The owner typically has to make monthly payments for a year or more until the new owner of the tax lien has recouped the entire balance of the lien plus interests.

If the owner of the property doesn’t make payments on the tax lien, the owner of the tax lien can foreclose on the property. Foreclosure happens in a small percentage of cases, and you shouldn’t approach tax lien investing as a way of acquiring properties. 

How to Start Investing in Tax Liens

City or county treasurers are responsible for issuing tax liens and collecting tax payments from property owners. Local governments occasionally hold auctions for tax liens.

You will have to contact the city or county treasurer to find out when they will hold the next auction. There are also associations like the National Tax Lien Association that provide you with upcoming auction dates once you become a member.

Some auctions take place online while others require you to visit the property and bid in person. There are rules for each auction. You should go over them carefully to find out how you should bid and when you have to pay for the tax lien if you win the auction.

Some auctions use a bid-down model. The city or county treasurer will establish a starting interest rate, and the tax lien will go to the investor who is willing to accept the lowest interest rate. Some auctions use a more traditional approach, and the lien goes to the investor who is willing to spend the most to purchase it.

If you win a tax lien auction, the city or county treasurer will issue a tax lien certificate. Once you make a payment for the tax lien, you will officially become the new creditor for the debt incurred by the property owner.

Depending on the state where you purchase a tax lien, you might have some legal responsibilities to fulfill. These responsibilities typically include notifying the property owner that you purchased the tax lien.

How Much Can You Expect to Earn by Investing in a Tax Lien?

In 98% of cases, the property owner ends up paying off the balance owed in property taxes. Very few tax liens end up with foreclosure, so it’s very unlikely that the property will become yours.

You have to pay the entirety of the balance on the tax lien when you purchase it from the city or county treasurer. You will usually have a few days after winning the auction to make this payment.

There is a large upfront investment with most tax liens. You will recoup your investment via monthly payments from the owner of the property. Each tax lien has a different timeline for the payments.

The interest rate will determine how much you can expect to earn with this investment. The interest rate can be as low as 5% or can exceed 30%. It’s typically around 10%. It’s a fairly interesting return compared to other investment vehicles, but keep in mind that there are a high upfront cost and an expiration date for collecting payments or foreclosing the property.

Some states give you the possibility to add penalties and other fees to the tax lien. You might be able to add auction fees to the balance of the lien. 

What to Consider Before Investing in a Tax Lien

A tax lien can become a steady source of revenue if the owner makes monthly payments on it. It’s an interesting way to diversify your portfolio and to invest in real estate. Tax liens typically yield predictable returns.

However, there are some questions to ask yourself before investing in a tax lien:

  • What kind of property are you interested in? Commercial tax liens tend to cost more.
  • How much is the property worth?
  • Can the owner afford to repay the tax lien?

There are cases where property owners have no intention of making payments on the tax lien because the property holds no value. You need to conduct due diligence and find out as much as you can about the property to figure out why the owner got behind on property taxes.

A property located in a high crime area or a home that sustained significant damage during a natural disaster would make for a poor investment.

You can foreclose the property if the owner doesn’t pay off the tax lien, but keep in mind that there are foreclosure fees to pay. It’s a process that requires your time and attention, and you might find that the property holds very little value once you foreclose it and become the new owner.

It’s possible to lose money when investing in tax lien since there is no guarantee that the property owner intends on making monthly payments, or that the property value is higher than the amounts owed in taxes.

You should also keep in mind that tax liens have an expiration date. If the lien expires, you won’t be able to collect payments or foreclose on the property.

Tax Lien Investing Tips

It’s important to select the right property if you want to bid on a tax lien. You should have the property appraised and spend between 3 and 7% of the property value when you purchase the tax lien.

Don’t conduct due diligence in advance. Seeing a tax lien on their property going up for auction is a strong motivation to pay off a property tax balance. A lot of property owners end up paying off their tax balance before the auction begins.

The list of tax liens published by city and county clerks often doesn’t reflect the tax liens available on the day of the auction. It’s best to wait until the last minute to do some research on the different properties to avoid wasting your time.

You should also do some research about interest rates in your state. Interest rates can vary a lot from one state to another, and some states allow you to add fees to the tax lien while others don’t.

As a rule of thumb, it’s best to avoid properties with a low value. You should also avoid tax liens on damaged properties. There is very little motivation for the owner to pay off the balance of the tax lien, and you would incur additional costs if you were to foreclose and become the new owner of the damaged property.

You should also find out if there are other creditors with a lien on the property. A bank that issued a mortgage can place a lien on a property if the owner stops making loan payments. You can’t foreclose on a property if there is another lien on it.

Just like with any other investment strategy, you can lower your risks by diversifying your investments. Look into purchasing several tax liens in different areas.

You can also invest in tax liens via funds managed by a bank or investment company. Financial institutions can purchase a large number of tax liens and consolidate them into a fund with regular returns. This approach lowers your risks and makes tax lien investing easier since you don’t have to look for liens or bid on them.

Tax liens are worth considering if you want to invest in real estate but don’t want to purchase a property. However, it’s crucial to conduct due diligence and select the right properties.

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