Learn about Tax Lien Investing: The 101 Course for Beginners
Among several little-known ways of investing in real estate, buying tax liens is one of the more misunderstood and least utilized methods.
There are many types of liens that can be placed on real estate property, including mechanic’s liens, “weed” liens, demolition liens, and judgment liens. All these tax liens are designed as ways to collect payment of debts or to levy a fine that will prompt action to resolve a nuisance.
Tax liens are regularly placed on properties by a municipality or agency to collect delinquent taxes. They are a form of “non-consensual” debt, differentiated from the “consensual” lien created between a debtor and creditor in the form of a mortgage or a contract for work or services. A tax lien represents a legal claim against the owner. The property is considered security for the payment of that debt.
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Tax liens are sold, under well-defined circumstances and usually under state mandates, to third parties and are considered low-risk opportunities for investors. Here are the reasons they are a low risk:
• Governmental jurisdictions––states, counties, municipalities and even school districts––fund their services through taxes collected. A shortage of funds, over time, means that services must be reduced. So, prudent governments and other authorized entities agree to pay a guaranteed interest rate to third-party investors in exchange for payment. In addition, the buyer of a tax lien might on occasion benefit from eventual foreclosure.
• The price of tax lien certificates is variable, sometimes based on the interest rate a buyer is willing to accept. Even though few tax lien investors ever actually acquire title to the property, tax lien certificates provide stable, long-term return. Interest is paid regularly as long as the investor makes regular payments. The investment value is secured by the underlying property, and in case of foreclosure, the holder of the tax lien is paid in full for its value. Tax liens are considered “fixed income” investments.
• In the case of foreclosure sales, liens are normally settled in order of filing: The oldest existing claims are paid first until there are no funds left from a sale to settle existing debt. Tax liens, however, take priority over many other types of liens. In New Jersey, a very favorable state for tax lien investing, the prevailing annual allowable interest rate is as high as 18 percent. The property tax liens are considered “first tier” debt for repayment, taking precedence over even federal tax deficiencies and mortgages.
• Underlying property value is a determining factor in the price actually charged for a tax lien certificate. Investors must always do their due diligence when responding to tax lien offers. All tax liens are priced somewhere between the actual amount of delinquent tax and the assessed property value. Associated interest, fees and costs of the sale are added. Although tax liens were once available (and in some places, still are) only through live auction, today online bidding is becoming more commonplace. Buyers of tax liens are not required to live within the jurisdiction, but other rules are strictly enforced.
• In some “premium” jurisdictions or where there are a number of tax liens to be sold, investors are allowed to pay a premium for tax lien certificates on desirable properties. Risk varies based on the amount of tax owed, the price paid, interest rate, underlying property value and any subsequent redemption penalties that might be levied.
Credit the Roman Empire for the initiation of tax lien investment opportunity. Private citizens in about 300 BC were granted the right to purchase regional tax collecting rights. In return, they received a guaranteed income stream. It was the first effort of a government to stabilize its revenue and assure the continuance of its public works programs. The same system was used by succeeding government entities. It helped a young America prosper in the 1800s and flourish after the Great Depression. Today, it fills a governmental need for stability and offers another benefit for the savvy investor.
This blog was provided by:
Gary Ashton REALTOR®
210 12th Ave South, Suite 201
Nashville, TN, 37203