Tax liens are investments made possible by state law. Governments love to use tax money, but they really don’t like being in the tax collection business. And they especially don’t like to be bankers. Governments want their money now, so they can balance their budgets. So they have a serious challenge when a taxpayer, for whatever reason, decides not to pay his property taxes on a particular parcel of real estate. In fact, sometimes it takes years to collect the taxes from the owner of the property, and sometimes the owner never pays the taxes owed. As much as governments hate being the bank, they hate being property owners even more. What they really want is the cash, and they want it now.
So instead of becoming a creditor of the property owner and waiting for the money until the taxpayer ponies up, many local governments (usually counties) have figured out how to get their money immediately. It’s called a tax lien. In the simplest terms, here’s what happens:
The government assesses taxes on a piece of property, which is called a parcel. In most cases, the owner will simply pay the taxes that are due.
But what if the owner of the land decides not to pay the taxes on time? Then what happens?
- The government puts a lien on the parcel for back taxes.
- Then the government sells the lien to an investor, such as you or me. The lien is sold at a public auction with an opening hid made up of the amount of back taxes and other costs.
- If the lien is sold at auction, multiple investors hid on the lien. Although variation exists among tax lien states, there are some general similarities. First, all primary sales must he held in a public auction and ordinary citizens like you and me may take part in the sale. Some states use a process in which the price of the lien is bid up (i.e., increased) based on competition for the lien. In this situation, the p1–ice paid for the lien may he hid higher, but the interest rate earned on the tax lien remains fixed and does not fluctuate due to the bidding. Other states use a bid down system. In this situation, the interest rate earned on a tax lien is bid down by the bidders. The standard interest rate on tax liens varies among states but can be as high as 18 percent.
- The lien earns simple interest based on the standard rate or auction final hid rate.
- The interest “accrues” (accumulates) until either the taxpayer or another lienholder (such as a bank holding a mortgage) ultimately pays the interest and the hack taxes to the investor in order to have the lien on his property removed.
- After a certain period of time if the lien is not paid, the investor can foreclose against the property and can end up owning the property outright for only the price of the hack taxes and foreclosure/legal fees.
The great thing about foreclosing on a tax lien is that a tax lien supersedes nearly all other liens. So if you are able to foreclose on a tax lien, you get the property for the cost of the unpaid taxes, and in the majority of situations, any other liens are wiped out. Pretty cool, huh? Well, at least it can be in the right circumstance, but more about that later. In any case, there are several important steps to investing in a tax lien, and we are going to take them one at a time.