Aspiring investors often explore numerous avenues to grow their wealth, one of the less-travelled roads being tax lien investing. Tax lien investing presents a unique opportunity in the property market, allowing investors to secure potentially high returns while helping local governments recover delinquent property taxes.
This comprehensive guide aims to unravel the intricacies of tax lien investing, offering insights into the process, potential benefits, and risks.
A Primer on Tax Liens
A tax lien is a legal claim imposed by a government entity on a property due to the owner’s failure to pay property taxes. When property owners neglect their tax obligations, the local government is authorized to place a lien on the property. The lien is a legal claim against the property for the unpaid amount, including any interest and penalties.
Understanding Tax Lien Certificates
The local government creates a tax lien certificate upon issuing a tax lien. This document outlines the amount owed and any accrued interest or penalties. Generally, tax lien certificates can be auctioned off to private investors, providing a quick way for governments to recover their losses.
Tax Lien Auctions: A Crucial Step in Tax Lien Investing
In several jurisdictions, tax lien certificates are sold through auctions. The highest bidder usually wins the certificate. However, the bidding process can be based either on the cash amount an investor will pay for the certificate or the interest rate they’re willing to accept.
In the case of cash offers, the certificate goes to the highest bidder. In the case of interest rate, it goes to the lowest bidder.
From Winning Bids To Foreclosures: The Tax Lien Investing Process
Once an investor successfully bids for a tax lien certificate at an auction, they assume responsibility for the tax bill, including any interest or fees owed. However, this doesn’t automatically confer ownership of the property.
The investor essentially gains the right to foreclose the property or recoup their investment if the homeowner eventually settles their tax bill.
Redemption and Repayment
After purchasing a tax lien certificate, two potential outcomes exist: either the homeowner settles their property taxes, or they don’t. In the former scenario, investors recoup their initial investment plus the interest rate bid at the auction.
Foreclosure and Ownership
Investors can initiate the foreclosure process if the property owner fails to pay their taxes. Depending on the jurisdiction, there might be a stipulated period within which investors must start foreclosure after purchasing the tax lien.
Failure to act within this period could result in losing the right to collect the investment. However, it’s worth noting that most homeowners usually pay their tax bills before foreclosure begins.
Tax Lien Investing: A Numbers Game
A host of factors influences the area of tax lien investing. These include increasing property tax values, delinquent property taxes, and the tax delinquency rate.
Property Tax Values
In recent years, property values have significantly increased in certain regions. For instance, property values rose by 9% in King County, Washington, from 2021 to 2022. This resulted in an additional $200 million in property taxes, amounting to $6.79 billion in 2022.
Delinquent Property Taxes
Understanding the scale of delinquent property taxes is crucial for tax lien investing. According to the National Tax Lien Association, approximately $21 billion of property taxes in the United States turn delinquent annually. Between $4 billion and $6 billion are posted for sale to the private sector each year.
Tax Delinquency Rates
The tax delinquency rate has been decreasing over the past decade. As per CoreLogic, 6.3% of taxpayers were delinquent on their property taxes in 2020, which declined to 5.9% in 2021. Keeping track of such rates is essential, as they can significantly influence the tax lien investing landscape.
Dipping Your Toes in Tax Lien Investing
Once you understand the fundamentals of tax lien investing, the next step involves actual participation. The process of investing in tax liens can be summarized in the following steps:
- Identify jurisdictions that hold tax lien certificate auctions.
- Participate and win a tax lien certificate auction.
- Pay the unpaid taxes and associated fees to obtain the tax lien certificate.
- Wait for the homeowner to redeem the tax lien certificate; initiate the foreclosure process if they fail.
Remember, tax lien investing is not a casual endeavour. It demands extensive research, due diligence, and a deep understanding of local laws and real estate dynamics.
Crucial Tips for Tax Lien Investors
Savvy tax lien investors need to conduct thorough due diligence on available properties. In certain scenarios, the current value of a property could be less than the amount of the lien. Additionally, other liens on the property could prevent the bidder from assuming its ownership.
Investors can gauge risk by dividing the face amount of the delinquent tax lien by the market value of the property. Higher ratio calculations indicate more significant risk.
Also, every piece of real estate in a given county with a tax lien is assigned a number within its respective parcel. Investors can use these numbers to obtain detailed information about the properties from the county, often available online.
Profiting from a Lien
The potential for profit in tax lien investing rests on a balanced mix of strategic actions and favourable circumstances. Upon winning a tax lien certificate, investors are typically required to immediately pay back the full amount of the lien to the issuing municipality.
The property owner must repay the investor the entire amount of the lien plus interest, which varies from one state to another, but is typically between 10% and 12%. The investor can foreclose on the property if the owner fails to repay the lien by the deadline. This, however, is a rare occurrence.
