Tax Lien Investing

A “lien” is a form of security interest where property is used to ensure repayment of a loan or performance of some other contractual obligation.  Think mortgage, for instance.

A “tax lien” is when the government puts a lien on property specifically because of taxes owed.  Until the taxes are paid up, the property owner can’t sell the property, just like if he or she had an unpaid mortgage.  It also puts the government in a position to foreclose on the property and take it over, again like a mortgage holder could if the owner wasn’t making the obligatory mortgage payments.

A “tax lien sale” is a public auction – sometimes held in person and now sometimes held online – where the government puts these tax liens up for sale to investors.  In effect, the investor is paying the government what it is owed in taxes, and in exchange the person who owes the taxes now owes that money plus interest to the investor, and if they do not pay by the specified time, it is the investor who can seize the property,

Tax lien sales can be an attractive investment in that the rate of return tends to be higher than with most investments.  In some states, an investor can get paid as much as 16% or 18% a year more than they had to pay for the tax lien.  Plus, tax liens take precedence over other liens, which adds a level of safety to the investment.  Most tax liens are redeemed before any foreclosure is necessary.

Still, investing in tax liens is not the kind of easy money it is sometimes made out to be, for a number of reasons:

* The investor must have the liquidity to pay in full for the tax lien immediately upon purchase.

* The relevant laws and regulations surrounding tax liens are among the most complicated in property law, and they vary from state to state, so investors who are not fully knowledgeable about these things can easily get tripped up and find that they don’t have the rights they thought they did, or that what they purchased isn’t worth what they thought it was. 

Homes purchased with government-insured financing such as FHA loans come under different rules than other property, each state has a different statute of redemption governing what the property owner has to do to hold onto the property after all, forfeiture of the property doesn’t give the investor the property but just the right to foreclose on the property which mean having to be conversant with all the rules and procedures of foreclosure, and so on.

* Major institutional investors have the resources to fully research these matters and tend to scoop up the most promising tax liens, leaving the less profitable liens for other investors.  One might end up with the right to seize property that is worth equal or less than what one paid for the tax lien.

* Even though the tax lien puts one first in line, a bankruptcy might still reduce the interest rate, or discharge part or all of the lien.

So tax lien investing tends to give an investor a nice rate of return, and it’s safe compared to most investments, but it has its pitfalls.  If this is a form of investing you are considering, you will definitely want to do your homework not only about the properties themselves but also all the laws and procedures concerning tax liens in a given jurisdiction.