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How Do Tax Lien Sales Work: Can You Buy Tax Lien Properties to Save Big?

Posted on Mon, Jun 03, 2013 @ 07:00 AM

Tax lien saleThese days, we've all heard about tax lien investing ... but what does it really mean, and more importantly, is it really as lucrative as many people think?

First off, let’s define what a tax lien is. A tax lien is placed on a property deed by a county or municipality if the owner fails to pay annual property taxes. It will only be removed if the owner pays off the taxes plus any penalties or interest accrued.

In addition, the owner cannot put the property up for sale until the lien is satisfied. As a matter of fact, all other claims, including the mortgage are subordinate to the tax lien, meaning the lien must be paid first. If the taxes and other debt are not paid off after a period of time, the local government can put the lien up for auction.

Note that it is the lien that is placed for auction, not the actual property at this point. And not all states use tax liens, some actually do sell the property immediately in a tax deed sale if the taxes are not paid.

And now for some terms:

Lienee: Owner of the lien (the county until the lien is auctioned)

Lienor: Owner of the property upon which taxes are owed.

If the lienor fails to pay the lienee the interest and outstanding lien the property is foreclosed, typically after a redemption period of 6-24 months depending on state mandate. The redemption period, by the way, is the period of time the lienor has to pay off the lien.

The owner of the lien makes money in a couple of ways:

  • Increased interest rates on the lien. When the lien is redeemed by the lienor the lienee receives all proceeds from the lien.
  • Ownership of property upon foreclosure. (Note: The property value is often 5-100 times the value of the lien, so for the price of the lien the lienee gets the entire property.)

There are a variety of processes for tax lien bidding. Which is used depends on the state:

Rate: The lien goes to the bidder who is prepared to accept the lowest interest rate.

Penalty: The lien goes to the bidder prepared to accept a certificate with the lowest penalty percentage rate. This penalty accrues until the lien is redeemed. If during the redemption period current taxes are not paid, the lien owner can then buy a new lien on the outstanding debt at the full penalty rate without going back into a bid.

Ownership: In this process, the lien owner and the property owner become co-owners of the property if it goes to foreclosure. But because the bidding process starts at a high interest rate and reduces until the lien is sold the lienee is guaranteed a fairly high interest rate. On the other hand, the co-owner who was previously the property owner can make taking possession of the property an expensive legal problem.

Round Robin: This is pretty straightforward. The auctioneer offers the lien successively to each bidder until someone buys it. The liens are offered at the highest rate allowed by statute. So, there is a guarantee of a high rate on the tax lien certificate with none of the co-ownership problems of the Ownership bidding model.

But it can be hard to obtain a lien that fits your needs and finances. If you pass on a lien you will just have to wait to see if that lien or another comes around that is suitable. This is great for large investors who can afford to buy the liens on the first go-round but can be hard on the small investor who may only be able to carry a couple of liens.

There are many benefits to investing in tax liens. For one thing, there are no fees on the investment (meaning a no-load investment) and there is no liability for the lien owner over the property. In other words, the lien owner is not responsible for insurance or maintenance. Whenever a property is foreclosed the lien owner enjoys a windfall profit and the risk of loss in this type of investment is pretty small. Also, the principal value is constant unlike a mortgage payout where the principal changes on a monthly basis.

Best of all, the property owner and subject of the tax lien has great incentive to pay the lien and interest rather than face the total loss of the property due to what is, really, a fairly small debt in comparison to the cost of a home. Statistics show that almost all tax liens are paid in full. So there aren’t a lot of investors out there who become unwilling homeowners.

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Tags: Real Estate, Finance