If a homeowner doesn’t pay their property taxes, the government can put a tax lien on their house. An unpaid tax lien can result in the homeowner losing their house through foreclosure. But did you know that tax liens can be bought by an investor? This is done through a tax lien certificate. If you’re interested in investing in properties at auction, consider working with a financial advisor to help you get your finances in order first.
What Is a Tax Lien Certificate?
A tax lien certificate is a certified claim on a property that has had a tax lien placed on it. Usually bought at auction by investors, tax lien certificates are sold by the county or municipality that levied the taxes. When they win the auction, the investor pays the back taxes. They then charge the current homeowner the back taxes plus an interest rate.
Not all areas issue tax liens. Currently, 29 states plus Washington D.C. allow the transferring of tax liens from the public to the private sector. If your area offers tax lien certificate investing, it’s an avenue that could result in high returns for you.
How Tax Lien Certificate Investing Works
If a homeowner owes back property taxes and a tax lien is placed on their home, the county or municipality can decide to auction off the rights to the tax lien. Here’s how investors can take advantage of tax lien investing.
Tax Lien Certificates Are Bid for at an Auction
When a homeowner does not pay their property taxes, the government can put the tax lien up for auction after the taxes have gone unpaid on the property for a specific timeframe. Investors will bid on the tax lien certificate.
How you win the auction depends on the auction and where it’s taking place. Some auctions require bidders to bid on the interest rate, with the municipality setting the maximum rate. The winner here is the one who bids the lowest rate. Other municipalities do it by cash amount, with the winning bid going to whoever will pay the most above the lien amount.
What Happens With the Winning Bidder
The winning bidder pays the property taxes that are owed, then they try to collect the back taxes from the homeowner. Homeowners sometimes have what’s called a “redemption period” of one to three years which they can pay off their tax debt, plus interest. During this period, the investor can potentially recoup their investment along with the interest.
However, if the homeowner does not pay the tax lien investor, the investor is responsible for starting the foreclosure process. This would involve the eviction of the homeowner and would give ownership of the property to the investor.
Average Rate of Return for Tax Lien Certificates
How much interest a tax lien investor collects depends heavily on multiple factors. These include the location, the value of the house, how much tax debt there is and how low they bid at auction. In general, the rate of return for tax lien certificates is 8% up to 30%.
Of course, with a higher interest rate often comes higher risk. The homeowner may be unable to pay the debt. While that would give the investor the house, what if they don’t want it or what if the back taxes were more than the value of the home? Let’s cover some of the pros and cons.
Pros and Cons of Tax Lien Certificate Investing
- High rate of return: Tax lien investing can offer a significant rate of return, often higher than other forms of investing.
- You don’t need a lot of money to start: Some tax lean certificates can be won at auction for as little as a few hundred or thousand dollars.
- If the property forecloses, you own the home: You could sell the home or use it as an investment property.
- Foreclosure: If the homeowner doesn’t pay the back taxes, you’ll need to foreclose. This can take time and money. On top of that, you won’t receive the interest rate you charged initially. Also, don’t underestimate how emotionally difficult it can be knowing that you’re kicking someone out of their home.
- If the property forecloses, you own the home: This can be a negative, too. If you own the home, you’ll need to pay taxes on it and pay for maintenance and repairs.
How Is Tax Lien Investing Different from Tax Deed Investing?
Tax lien investing and tax deed investing are two different things. While they’re both based on delinquent property tax debt, the rights given to the investor are different. With tax lien certificates, the investor is buying the right to collect the tax debt and charge interest on it. With a tax deed, the investor is buying the property itself. Understanding the differences can help you make better investment decisions.
The Bottom Line
Investing in a tax lien certificate can be lucrative, depending on where you live. Keep in mind that different localities have different laws and practices around offering tax lien certificates, including whether they offer them at all. They come with their own risks, but if you enter the investment prepared, you will know how to address them.
Tips for Investing
- If you’re interested in real estate investing or tax-lien investing, talk with a financial advisor. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Our free property tax calculator can help you understand property taxes for an investment property or your current home. Compare a specific property’s taxes to the average taxes in the area.
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