- What is a tax lien?
- What is tax lien investing?
- Are tax liens a good investment?
- Tax lien pros and cons
- Tips for buying tax liens
As an investor, your main goal is to look for new opportunities and evaluate risk vs. reward. While it’s been around for years, tax lien investing increases in popularity among investors of nearly every skill level.
But buying tax liens is not for everyone, as it requires up-front capital and will take at least 120 days to see a return on investment. Though there are risks associated, the returns can be tremendous depending on the property at hand.
Before you consider your own foray into tax lien investing, here’s a quick primer on this often profitable—though sometimes confusing—investment strategy.
What Is A Tax Lien?
A tax lien is a legal claim applied to a property when the owner fails to pay required taxes to the government. Tax liens total the amount of outstanding taxes, plus interest or additional fees accumulated by the property owner. They essentially serve as red flags, and properties with tax liens cannot be sold or refinanced until the outstanding taxes have been paid.
Tax liens are relatively common across the United States. According to Investopedia, there was about $14 billion in unpaid property taxes in 2017. Tax lien certificates are issued by local governments and can ultimately be auctioned off to investors. By selling tax liens, the city can immediately earn back money lost in taxes. The widespread nature of tax liens has led to increased popularity among investors.
According to experts at CollectiveRay, “Tax liens are legal claims against the property of individuals and businesses that fail to pay their taxes owed to the government. Property subject to liens can’t be sold or refinanced until taxes are paid and the liens are removed.
You can purchase tax lien properties the same way that you can purchase and sell properties at an auction. The tax lien properties seem appealing to investors since you have the opportunity to purchase property for a fraction of the market price.”
Navigating a tax lien auction can be somewhat intimidating for investors unfamiliar with the process. Each locality will run tax lien auctions slightly differently, but the overall process involves bidding on the certificate to the lien. Investors can win a certificate by bidding the highest cash amount, or by bidding down the interest rate.
Once the auction is complete, the next step is to pay for the tax bill and debt associated with the property. The homeowner will then have a period of time to pay the balance before the investor can initiate the foreclosure process. In many states, investors are required to notify property owners about the purchase of the lien.
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What Is Tax Lien Investing?
Tax lien investing is the act of buying the delinquent tax lien on a property and earning profits as the property owner pays interest on the certificate or from the liquidation of the collateral securing the loan. This gives you the right to take the property’s deed if the owner does not pay off the entire delinquent tax amount, plus any fees within the redemption period, typically 120 days.
In most cases, the owner has had months, if not years, to pay the taxes before the bidding process. An extra 120 days does not usually change anything.
Are Tax Liens A Good Investment?
Tax lien certificates can certainly be an excellent investment to add to your portfolio, as long as you know how to find tax-delinquent properties. Like any other investment, the key is to know as much as you can about the property, the neighborhood, and the town in general. You never want to get stuck with a property that you don’t see any upside in.
How Do Tax Liens Affect Mortgages?
Tax liens do not necessarily affect mortgages, but they do impact homeowners (and their credit). Property tax liens are treated as a separate debt alongside a homeowner’s mortgage. When a property with a lien is sold, the lien remains associated with the property while the buyer applies for a unique mortgage loan. It is then the new buyer’s responsibility to request to remove the lien with the county.
Typically, after the sale of a tax lien there is a period of time where the previous owner can pay the delinquent property taxes. The exact length of time varies depending on the state. Property tax liens remain on the previous owner’s credit report even after the property has sold. This could affect their future ability to apply for and secure a new mortgage until the outstanding line has been resolved.
Tax Lien Investing Pros And Cons
There’s no question investing in tax lien properties does contain some amount of uncertainty. But when compared to other forms of investing, it can actually have a much lower risk profile. (Though this can depend widely on certain factors.)
Quite simply, the rules and guidelines regarding tax liens vary depending on what state a property is in. There can be some variance regarding the redemption period, return rates, and the bidding process itself. It’s important to know the general rules before you make a bid in your state. To better prepare yourself, you must evaluate the pros and cons.
Tax Lien Investing Pros
- Low capital requirement: Tax lien certificate investing offers a much lower capital requirement when compared to other forms of investing—it’s possible to jump into this asset class for as little as a couple hundred dollars.
- Rate of return: The other big advantage investing in tax liens gives you is a (fairly) standard rate of return. Unlike flip investments, which can be volatile, with tax lien investing, you have a solid understanding of what your return will be—without having to second-guess the market.
- Lump sum payment: You are paid a fixed sum when the tax lien investment resolves, which means that it’s easy to calculate exactly how much you’ll be receiving and what your rate of return is. Also, because the payment is not in the form of an ongoing residual, you get all of your returns at once.
- Passive investments: Researching and buying tax liens does not require the same level of involvement as other real estate strategies, such as wholesaling or rehabbing houses. Instead, this strategy involves a more passive approach allowing you to profit from real estate without the same amount of involvement.
Tax Lien Investing Cons
- Lack of recurring income: For some investors, the fixed payment aspect of buying tax liens can be viewed as a drawback. When receiving a fixed payment, it may not align with some investors’ financial goals, especially if they are looking to create residual income avenues over time.
- Possibility of subsequent liens: Even though tax lien investment requires very little up-front capital, they can (on occasion) require more capital as the process moves forward. This is because, as the initial lien holder, you will be required to purchase any subsequent liens. (New tax liens take precedence over old liens; sad but true.)
- Competition: The other slight disadvantage is the amount of competition you will likely face, usually from money managers and fellow investors, in your pursuit of tax liens to purchase. The best remedy for this is to know your geographic market well and target low-cost liens—in the $100-$200 range. (The big money managers and investment firms are looking for a higher yield than these smaller investments can provide.)
- Neglected Properties: Be cautious of distressed properties or areas with environmental damage. Investors may not want to get involved in areas with chemicals or hazardous materials on the property. These could signal cases where the owner is simply unable to pay the outstanding taxes, and investors will not see any returns.
How To Buy Tax Liens in 6 Steps
Investors interested in buying tax liens will need to learn how real estate auctions work. While these processes are not complicated, they can be surprising to new investors. If you are interested in getting started, review the following steps to buying tax liens:
- Learn About Tax Liens And Real Estate Auctions: There are two ways to profit from tax lien investing: through interest payments or taking ownership of the property. The entire process should be handled with care and under the guidance of a real estate attorney. Actually, purchasing a tax lien is typically done at a real estate auction. Take time to really understand the real estate auction process before you attempt to bid on any tax liens.
- Decide On A Target Area: Tax liens are assigned by county, so it will be helpful to narrow down your target area before looking for investments. This website offers a list of counties in the U.S. by state. Note that areas with financial strain may be more willing to offer deals on tax lien properties. Check out public records to find the financial status of counties near you and find which areas represent the most promise.
- Scout Different Properties: Auctions do prevent buyers from seeing the inside of a property prior to sale. Since you will not have seen the property without the homeowner’s consent, you may not be aware of the property’s condition. However, if you get into a bidding war and overpay, you may take ownership with negative equity before even unlocking the front door. That’s why it’s important to do your homework and scout out potential properties before you attend an auction.
- Make A List And Bid On A Home: After you identify a few properties that you are interested in, it’s time to attend a real estate auction. Establish your maximum bid before attending to help prevent yourself from accidentally overpaying. Then, attend the auction and place a bid on the property you want. Be sure to research the county’s payment requirements (whether cash or check) so you are prepared if your bid is accepted. If you are the winning bidder, you will take an ownership interest in the property and the lien.
- Notify The Homeowners: Follow the laws in your area after obtaining the tax lien. In some cases, this may require notifying the homeowners by sending a certified letter to the property. The letter should inform them that you have purchased the lien and state how much they owe in back taxes on the property. Due to the overall lien process, the letter will likely not surprise the homeowners.
- Collect Your Money (Or Property): Once all parties understand the lien agreement, your only job as an investor is to collect interest as the homeowners make back payments. The period can vary, but on average, it is 120 days. If the homeowner does not have the money, the auction winner becomes the lien holder and, ultimately, the homeowner. Depending on any other liens on the property title, you may need a good amount of capital to pay everything off. Always be prepared for this possibility when tax lien investing.
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Pro Tips For Buying Tax Liens
Now that you understand the benefits of tax lien investing and how to purchase tax liens, here is more information that you should know before getting started. Read through the following tips before trying your hand at tax lien investments:
- Tax Liens Aren’t Always Properties: While ending up with a property is a genuine outcome when tax lien investing, it does not always come to that. Sometimes homeowners will meet the established deadlines and pay off the liens on the property. Investors would then only profit from interest income. This can still be a lucrative opportunity, but it is important not to go into tax lien investing with your sights entirely set on property ownership.
- Tax Lien Investing Laws Vary: Tax liens are implemented by county, meaning the process of purchasing them will vary by county as well. Familiarize yourself with local laws while you search for potential investments. Depending on your area, the purchase process could be much easier than others or vice versa.
- Diversification Is Key: A tax lien purchase takes time and capital, making it a challenging primary investment strategy for many entrepreneurs. There are several benefits to a real estate tax lien, but at the same time, investors should remember the importance of diversification. It is a good idea to identify and pursue a few investment options to create a diverse portfolio. That way, you can spread out risk and guarantee a few different sources of cash flow at the same time.
- Keep ROI In Mind: Identify your financial goals before deciding to buy tax lien certificates to determine if the return on investment (ROI) is right for you. As I mentioned above, tax liens can be highly lucrative, depending on your location. Most states will limit the amount of interest charged on a tax lien certificate, though some states will have higher limits than others. The price of tax lien certificates can also vary by state, which could cut into an investor’s potential profits. Always research your area before getting started.
- Consider Private Lending: If you have the capital available to purchase tax liens, consider other ways you could invest that money as well. While tax liens may align with your investment goals, there may be other opportunities that result in higher returns. For example, a private lending scenario could allow you to generate more interest income than a tax lien. If you want to learn more about becoming a private lender, be sure to read this guide.
Passively Invest in a National Tax Lien Association
Since tax lien investing involves a significant amount of due diligence, it can be beneficial to passively invest through a National Tax Lien Association (NTLA) institutional investor. Studies show around 80% of tax lien certificates are sold to NTLA members. The cost for an NTLA membership for investors with less than $1 million is around $500. Based on their investment portfolio size, an NTLA membership fee can range from $2,000 – $10,000 for institutional investors and offer a 4% to 9% range of returns per year.
Tax Lien Vs. Tax Deed Investing
While similar, tax liens and tax deeds have a different sale auction process. Tax deed investing means bidding on the property title at auction instead of a rate of return. When a person bids and wins at a tax deed auction, the tax deed is transferred to the winning bidder, and they receive ownership and interest of the property. If the state has a redemption period, the property owner can pay the delinquent taxes on the property and redeem their ownership. If the state does not have a redemption period, the winning bidder will receive the property, and any of the previous owner’s debts will be erased.
Tax lien sales occur within 36 states, and 31 states allow tax deed sales (some allow both). The specific buying process of these sales vary by region, so be sure to research the regulations of the area you are looking to buy in before getting started.
Tax lien investing can be a good way to see a 12 to 18 percent return on your investment, but it is not without heavy competition and some degree of risk. Before you consider tax liens, find out what the guidelines are in your specific state, and attend an auction to get a feel of the process. Tax liens can be a great investment, but they can also set your business back years if you are not careful. Like most things in life, the best tax lien investing guidelines revolve around doing your homework, and then when you see an opportunity, pull the trigger.
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The information presented is not intended to be used as the sole basis of any investment decisions, nor should it be construed as advice designed to meet the investment needs of any particular investor. Nothing provided shall constitute financial, tax, legal, or accounting advice or individually tailored investment advice. This information is for educational purposes only.