Tax lien investing is an indirect route to real estate investment by purchasing tax lien certificates. Forbes defines a tax lien as a legal claim on an individual’s property when the owner hasn’t paid a property tax debt. In addition, Forbes notes that a lien is collateral for a debt or accrued taxes owed to the government.
The local government may trade the claims on collateral with private investors interested in this investment. More often, this type of investment generates above-average returns. However, property liens may also carry considerable risks. So, you need to be knowledgeable in this type of investment.
Below is what you need to know before starting tax lien investing.
1. How Do I Start Investing in Tax Liens?
Conducting thorough research is essential to gain valuable insights into real estate and tax lien investments. However, going beyond research and seeking real estate mentorship is highly recommended to capitalize on these unique investment opportunities fully. Learning from experienced professionals in the real estate field can provide invaluable guidance and knowledge, allowing individuals to navigate potential pitfalls associated with tax lien investments because this type of investment offers enticing yields but also has inherent risks.
By acquiring real estate knowledge and mentorship, you can understand the intricacies involved in depth, enabling you to approach real estate and tax lien investments with confidence and strategic decision-making.
Another thing to consider before participating in a tax lien auction is that you should contact the local tax collector. They will provide you with current information on local tax lien auctions. In addition, through your local tax revenue office, you will also know the requirements to participate.
Ensure that you have carried out due research on every property. It will help you establish the properties’ current state and value. So, by bidding, you should be aware of payment requirements. In addition, it would help if you recognized everything involved in the foreclosure process.
2. How Does Tax Lien Investing Work?
Local governments place liens on a property with unpaid taxes in tax lien investing. Hence, tax lien certificates are created, which you can buy. Some states in the US allow for the sale of tax lien certificates. Tax lien investing is a flourishing business due to high delinquent property taxes amounting to more than $20 billion yearly. Here is how tax lien investing works.
Creation of the Tax Lien Certificate
One of the ways local governments raise revenue is through the levying of taxes on properties. The local government can place a lien on a property if the tax has not been paid. The certificate will show the amount of tax due, interest, and penalties, where applicable. In addition, the government can foreclose any property if the owner doesn’t meet their tax obligations.
Auction of Tax Lien Certificate
In some states, the government can sell tax lien certificates to private investors. It is an easy way for the government to recover losses. The sale takes place at a tax lien auction. Therefore, the highest bidder takes the certificate.
Bidding on The Tax Lien Certificate
Investors can bid for a tax lien certificate in cash or on the interest rate. For cash offers, the highest bidder wins the certificate. However, if on the interest rate, the lowest bidder goes with the certificate. Therefore, if you bid for the lowest interest rate, your expected profit will be low.
Winning Bidder Owns Tax Lien Certificate
Whoever wins the tax lien auction becomes the owner of the tax lien certificate. Nonetheless, the winner is not the owner of the property. But they acquire the right to own the property when the government forecloses it. Alternatively, they are paid back if the property owner pays the tax bill.
Winning Investor Pays Taxes Owed
Upon winning the tax lien auction, the winner is responsible for paying the tax bill plus the interest owed. The property owner can pay the new investor within the redemption period or risk foreclosure. According to US News, about 98% of homeowners redeem the property before foreclosure.
Either Repayment or Foreclosure
There are only two outcomes once a tax lien certificate has been bought. First, the property owner pays a tax bill or fails to pay. If they pay, the investor receives the initial investment and interest rate they had bid. The investor can initiate foreclosure if the property owner fails to pay taxes.
3. Pros and Cons of Tax Lien Investing
Tax lien investing has a fair share of advantages but does not lack downsides. Here are the benefits and setbacks.
Pros
- Low investment cost
- Means of portfolio diversification
- Provides guaranteed returns
Cons
- Some properties are neglected or abandoned
- Minimal profits due to bidding competition
Final Thoughts
Tax lien investing can be a great alternative investment route that often brings generous internal rates of return. However, you may need due diligence to profit from this investment, together with a solid education in the field and the support of other real estate professionals.
