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 Tax lien investing is the practice of paying delinquent property taxes for another party. When an investor purchases a tax lien certificate, they become a lien holder on the property itself. This gives the investor a legal right to foreclose on the property under certain conditions. In fact, the property cannot even be sold or refinanced until the lien is satisfied.
The Tax Lien Process
The exact process is fairly complex, but is also fairly consistent across the United States. In most cases, the process starts when a homeowner is delinquent in paying real estate taxes or other fees collected by the city or county tax authorities. The thresholds might vary by state, but after a threshold of time has been satisfied, the city or county government has a right to issue a tax lien against the property in question.
The lien is usually sold at auction held by the county at pre-established times each year. These auctions proceed very quickly and each bidder is usually required to fill out an application before participating. Prior to each auction, the county will also run a public notice in local papers notifying the public of the auction date and time.
Your county tax office should have all the materials and information needed to participate in the tax lien auction. Keep in mind that rules and applications may vary with each county. Don't assume that an application for one county can be used in another. A simple telephone call should get you the information you need.
Tax Lien Sales and Auctions
The exact tax lien sales process will vary from state to state and although most auctions require the bidders to be physically assembled at a given location, online / internet-based auctions are becoming more common.
Winning Bidders in Auctions
Often there are multiple parties interested in the same lien. When that happens, the rules of the auction will determine the winning bidder. Normally, tax lien auctions will use one of the following five methods to determine the successful bidder:
- Bidding Down Interest
- Premiums Paid
- Randomly Selected Winners
- Bidding Down Ownership
- Rotating Winners
Each of these bidding processes is explained in more detail below.
Bid Down Interest
Under the bid down interest method, the stated rate of return offered in the auction is considered the maximum rate allowed. In this type of lien auction, each bidder is allowed to bid down the rate of return. The bidder willing to accept the lowest rate of return is the winner of the lien.
If there are multiple investors willing to accept the same low rate, then one of the methods described below can be used as a tie breaker and determine the ultimate lien winner.
Premium Auction
In a premium tax lien auction, the winning bidder is the investor that is willing to pay the highest premium on a given lien. A premium is an excess amount over the lien amount that the bidder is willing to pay. Premiums are not paid back to winning bidders and often interest is not payable on these premiums.
Random Selection of Lien Winners
In some jurisdictions, the winner of a tax lien is randomly selected from those willing to bid on a lien. Normally, a computer and using a random number generator is used to make the selection, but some jurisdictions may use simpler methods - akin to picking a name out of a hat. This method is often used when it's necessary to break a tie.
Rotational Selection of Lien Winners
Under the rotational selection of lien winner method, each bidder is given a number. The first lien up for auction is offered to the person assigned to number one. That person can choose to buy or refuse the lien. If refused, then the tax lien is offered to the person holding number two. The process continues until someone accepts to purchase the lien.
Bidders participating in this type of auction have very little control over what liens they will be offered.
Bid Down Ownership Method
The bid down ownership auction is not very common. In this type of lien auction, the investor agrees to bid down the ownership of the property. The winning bidder is the investor willing to receive the lowest percentage of the lien proceeds if the lien is redeemed.
This is perhaps the least popular of the auction methods with bidders. Many investors are unwilling to split a property with another party and participation may be less than robust.
Liens Not Sold at Auction
If a tax lien is not sold to investors at auction, they are considered struck, or sold, to the party holding the auction itself - which is frequently the county. There are states that allow liens that are not sold at auction to be purchased in an over-the-counter manner.
Many times tax liens that are not sold at auction involve "worthless" property since bidders would certainly be interested in properties having any real value.
Government Funding Through Tax Liens
The entire concept of purchasing a lien on someone else's property might be unpalatable to some, but keep in mind that the county depends on these taxes to provide essential services to the community. That is why the law allows for the auctioning of tax liens and tax deeds. By selling the lien, the county gets the funds it needs and the investor inherits:
- The rights to payment of the taxes owed, penalties, and interest payments.
- The rights to the property itself if non-payment occurs and foreclosure proceedings ensue.
Rights of Tax Lien Investors
In some counties, the lien holder agrees to pay any subsequent unpaid property taxes until the redemption period has expired. If the lien holder declines to pay any of these taxes, then another lien holder can take possession of the lien.
Redemption of Tax Liens
When the redemption period expires, the lien holder can initiate foreclosure on the property. The foreclosure proceedings are initially paid by the lien holder and usually result in the property's title being transferred to the lien holder or a tax deed sale. In the case of a tax deed sale, the lien holder usually has the right of first bid.
All through this redemption process, the original property owner has the opportunity to repay the lien and any interest due. In addition, the original property owner may also have to pay for the cost of the foreclosure proceeding.
If the lien holder does not act within a given timeframe to foreclose on the property, their rights to the property are forfeited and they no longer receive any return on their investment.
Risk and Return of Tax Lien Investing
Even with tax liens we have the laws of risk and return at work. If the taxpayer continues to make payments of tax and penalties, then the investor is compensated for the risk they took. If payments stop, then the investor has collateral - the property itself - which can be sold off to satisfy the lien.
Keep in mind that tax lien investing is not a new idea. There will be real competition for properties that are in good shape. These same properties are likely to be sold before foreclosure ever takes place. That's still good for the investor because their lien would be satisfied at sale. But the point is that the investor needs to do their research and understand exactly what they are purchasing.
The forces of market supply and demand are always at work, even at auctions, so please make sure you do your homework before acquiring your first tax lien.
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