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.
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.
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.
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:
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.
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.
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.
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.
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.
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.