Tax Liens Investing: The Ultimate Guide

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Tax Lien Investing 101

Mastering the Little-Known Investing Niche of Tax Liens

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If you are a real estate investor considering diversifying your investment portfolio, there is an often-overlooked real estate niche that provides excellent returns with a relatively low entry barrier.

Investing in tax liens.

In this article, we will break down:

• What tax liens are
• The advantages and disadvantages of investing in tax liens
• The difference between tax liens and tax deeds
• Frequently asked questions associated with investing in tax liens

If you’re ready to learn whether or not investing in tax liens is right for your real estate business, let’s get started! 

What are Tax Liens?

First, let’s break down what tax liens are.

Tax liens are issued when a property owner does not pay the real estate taxes they owe to the municipality in which the building or piece of land is located. 

The property may not be sold or refinanced until the owners obtain a lien release once the taxes are paid off. 

In 28 states, towns and counties may issue a tax lien certificate allowing the certificate owner to claim the property until the taxes and any associated fees are paid off and sell it to the highest bidder. 

So how can you invest in tax liens?

What is Tax Lien Investing?

Tax lien investing consists of purchasing tax liens from the municipality to be paid back by the property owner. 

Lienholders can charge the property owner an interest rate and include any penalty fees or premiums in their repayment plan. 

Depending on the auction, the bids are based on the cash amount the municipality is willing to accept for the tax lien certificate (the highest bid wins) or on the interest rate the investor may charge the property owner (the lowest bid wins). 

If the property owners fail to do so by a set deadline, the tax lien holder can foreclose on the property. 

However, it is not the typical outcome for tax lien investing since most owners repay their debt in time. 

How Does Tax Lien Investing Work?

Let’s take a closer look at how tax lien investing works step by step. 

1. A tax lien certificate is created by the local municipality.

Local governments create a tax lien certificate when a homeowner does not pay their annual property tax bill. 

The certificate includes the amount of taxes owed on the property, along with any additional financial penalties. 

The property can go into foreclosure when the homeowner does not become current with the overdue taxes and penalties. 

2. The tax lien certificate goes up for auction.

In the United States, 28 states allow the government to sell tax lien certificates to private investors. 

For more information in your area, check with your local tax revenue office. 

3. Investors place bids on the tax lien certificate.

Tax liens can be sold for a cash amount, or the interest rate a bidder is willing to accept. 

The certificate goes to the highest cash bidder or the lowest if you are bidding on the interest rate (what’s known as “bidding down the interest rate”.)

4. The investor with the certificate takes control of the tax lien.

The winning bidder doesn’t own the property, but the tax lien certificate gives them the right to control it once the overdue tax bill is paid in full. 

5. The investor covers the owed taxes.

While homeowners have a specific amount of time to settle up their tax bills, the investor is responsible for paying when they take possession of the tax lien certificate. 

6. Repay the taxes or foreclosure starts.

If the homeowner pays the back taxes and penalties, the investor recoups their money without taking ownership of the property. 

Homeowners that do not pay go into foreclosure. 

The investor can take possession of the property and put it back on the market. 

Investing in Tax Liens vs Investing in Tax Deeds

Both tax liens and tax deeds are consequences homeowners must face when property taxes go unpaid. However, unlike a tax lien, a tax deed transfers the title of the property itself and any rights attached to it to the buyer. Some states allow the property owner to pay back their delinquent property taxes and any fees and penalties to redeem their rights to the property.

Investing in Tax Lien Advantages

Low Entry Barrier

Entrance barriers for tax lien investing are relatively low compared to other forms of real estate investments, which allows investors to diversify their portfolio to other forms of assets (commercial, industrial, residential, etc.) or other communities. In some cases, investors purchase the tax lien certificates for as low as a few hundred dollars. 

High-Interest Rates

Tax lien investing also allows charging higher rates than other forms of investing. The maximum interest rate varies by state, but keep in mind that your returns will be lower if you bid on the interest rate at auction. 

Specific Returns

Finally, it is easier to get a clear idea of your returns with tax lien investing since you can calculate precisely how much you will receive from the property owner. 

Investing in Tax Lien disadvantages

Like any form of investing, tax lien investing is not without risks. 

Research & Education

Tax lien investing requires a significant amount of research and real estate knowledge from the investor to be profitable. 

For example, the property value needs to be significantly higher than the amount of tax due. If the market value is lower, the homeowner is unlikely to repay his debt. 

Therefore, the investor should do a thorough tax lien search before bidding. It should include:

• the condition of the property
• its location (possibility of environmental damage, for example)
• and more

You should also be very familiar with the local rules regarding tax lien investing, communication with the property owner, and lien release in the municipality you are considering. 

Foreclosure Can Be Expensive

If the homeowner decides to default on the loan, the investor may recoup at least part of their costs by taking possession of the property. However, some states do not allow investors to start the foreclosure until a set date, and foreclosing is a lengthy and expensive process. 

Beware of the Expiration Date

Beware that tax lien certificates have an expiration date after the end of the redemption period. Once the date expires, you will no longer have rights on the property, and any investor can make a claim if subsequent liens were issued. 

Competition

With the increase in competition from larger companies, profitable tax lien investing has become more complex. 

Investing in Tax Liens: Getting Started in 3 Steps

Investing in tax liens may seem complicated. Here is how to get started. 

Step 1: Understand Rules and Regulations 

The first step is to familiarize yourself with the rules and regulations in place regarding lien release, redemption period, how to communicate with the property owner, return rates, and the bidding process itself. 

Step 2: Find Tax Liens for Sale

Next, find tax liens for sale. This can be done through auctions offering tax liens for sale. It is best to begin your journey into tax lien investing in an area you are familiar with. 

However, keep in mind that not all states allow municipalities to offer tax liens for sale to investors. 

Your local tax revenue office can direct you towards the next auction and the requirements you must meet to participate. 

Step 3: Bid on Tax Liens

You can then bid on the tax liens. 

Again, keep in mind the number you are comfortable investing in, taking into account:

• additional fees 
• older liens
• renovation costs 
• and so on

If you are intimidated by the process or prefer a more passive approach to tax lien investing, you can look into organizations such as the National Tax Liens Association. 

5 Tips For Buying Tax Liens

Whether you are just getting started with investing in tax liens or you’ve already investing in a few, it’s always good to keep tips for profitable investing in mind. 

1. Learn about the process involved with buying a tax lien at a real estate auction.
2. Decide on a neighborhood or area with financial promise. Local tax records can give you a general idea of the property’s overall value. 
3. Visit potential properties before the real estate auction to gauge the condition and if it is worth the amount of the tax lien. 
4. Have a list of potential properties ready for the auction. Bidding is often fast-paced, and you don’t want to miss out on a property you are interested in. 
5. Always have a set budget. It is easy to get caught up in a bidding war where you may end up paying more for the tax lien certificate than the property is actually worth. 

Investing in Tax Liens: 3 Investing Strategies

Tax lien investing requires thorough research on the local rules and tax lien search. You should also have a strategy in place for the most profitable outcome. 

Investing in Tax Liens Strategy #1: Buy and Hold

Buy and Hold can be an excellent strategy in areas with the highest interest rates, such as Florida or Iowa, which have an 18% and 24% maximum interest rate. 

Your profits will increase over time until you authorize the lien release once the property owners pay off their debt or you proceed to foreclosure. 

Investing in Tax Liens Strategy #2: Foreclosure

If foreclosure is your goal, look into properties in states like Florida, which allows you to start a foreclosure procedure as soon as you become the lien holder. 

However, beware that there may be additional costs, such as older liens, that you may need to repay before obtaining rights to the title. 

Investing in Tax Liens Strategy #3: Resell

Some states also allow you to resell your tax lien to another investor if you decide that tax lien investing is not for you or if you prefer to avoid getting your money tied up. 

Investing in Tax Liens FAQs

Here are some of the most frequently asked questions associated with tax liens. 

Q: Is buying tax liens profitable?

Tax liens can provide high returns for educated investors. 

However, it requires an excellent understanding of the local real estate market and the local laws and regulations regarding tax liens in the area you are considering since they vary widely. 

Q. Are Tax Liens A Good Investment?

Tax liens often make good investments, but there are associated risks. 

Tax liens have expiration dates for the homeowner and lien holder. An investor’s right to take possession of the property expires with the lien. It also means the investor cannot recoup their initial investment. 

Q. How Do Tax Liens Affect Mortgages?

Tax liens do not affect mortgages for the investor. However, a tax lien can affect the homeowner. 

Even though a tax lien is not listed on a credit report, the information will still come up when a lender does a search for any liens and other outstanding debt. 

Individuals with tax liens are less likely to receive mortgage approval since they are at a higher risk of defaulting on their home loans. 

Q: What are the risks of buying tax liens?

Tax liens may not be profitable if the value of the tax lien is higher than the property's market value. 

There may also be hidden costs and expenses, such as older liens, that would need to be paid off to get ownership of the title. 

Q: How does purchasing a tax lien work?

Investors purchase tax liens municipalities issue against delinquent property taxes. 

The property owner must pay back the lienholder with interest within a set redemption time. 

If they fail to do so, the investor can foreclose on the property.  

Q: What percentage of tax liens are redeemed?

According to Brad Westover, executive director of the National Tax Lien Association, approximately 98% of property owners redeem the property before the foreclosure process starts. 

Investing in Tax Liens: The Bottom Line

Tax liens are one of the many real estate niches that can produce a profit, but it is not without risks. 

The best way to mitigate those risks is to grow your real estate knowledge so that your next investment deal will be the most profitable one yet.