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Tax Lien Investing: A Beginner’s Guide

As an investor, you’re constantly looking for new opportunities and evaluating risk vs. reward. While it’s been around for years, tax lien investing is increasing in popularity among investors of nearly very level.

But buying tax liens is not for every investor, as it requires up-front capital and will take at least 120 days to see a return on investment. The returns can be tremendous, depending on the state you invest in and the specific property, but there are risks associated as well.

Before you consider your own foray into tax lien investing, here’s a quick primer on this often profitable — though confusing — investor strategy.

Understanding Tax Lien Investing

Tax deed investing

1. What is Tax Lien Investing?

With tax lien investing, you are buying the delinquent tax lien on a property which is in the first lien position, or has first priority from any liquidation of the collateral which secures the loan. This gives you the right to take the deed of the property 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.

2. How Risky Are They?

There’s no question investing in tax lien properties does contain it within some amount of risk. But when compared to other forms of investing it can actually have a much-lower risk profile. (Though this can depend widely on the state the property is in.)

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, rates of return and the bidding process itself. It’s important to know how each state operates before you make a bid.

3. What are the Advantages of Investing in Tax Liens?

There are two crucial advantages that tax deed investing gives you. One, a much-lower capital requirement than other forms of investing — it’s possible to jump into this asset class for as little as a couple hundred dollars.

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 your will be — without having to second-guess the market.

4. What are the Disadvantages?

Well, aside from the lack of recurring income — you are paid a fixed sum when the tax lien investment resolves, not an ongoing residiual — there are two main drawbacks to this type of investing.

One, is 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.)

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.)

5. How Does the Process Work?

The bidding process for purchasing tax liens is typically preformed as an auction, preventing potential buyers from seeing the inside of the property prior to sale. If you are the winning bidder, you take ownership interest in the property and the lien.

If the homeowner does not come up with the money, the auction winner becomes the lien holder and ultimately the homeowner. This can be a good news/bad news scenario. First, as the owner you will need to clean the slate and see what other liens are on title. This may require a good amount of capital to pay any liens off.

Secondly, since you have not seen the property without the homeowner’s consent, you may not be aware of the condition of the property. If you got in a bidding war and overpaid, you may take ownership with negative equity before you unlock the front door. This is why it’s important to do your homework and really study each property before jumping in with a bid. (And of course really understand the real estate auction process.)

How to Make Tax Liens Work for You

The key, like any other investment, 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.

Tax lien investing can be a good way to see 12-18 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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