Tax Lien Investing – Definition, Risks, and Benefits
by Shahnawaz Alam Investing 14 August 2023
Even though it feels tempting, sometimes it is wise not to eat the whole fruit in one bite. This is the advice most experts would provide to novice investors willing to try tax lien investing.
Yes, tax lien investing does give your portfolio exposure to the real estate industry. However, is it really worth it? Yes, there is a chance of novice investors getting burned or drowning if they are not careful.
Go through this article to know why tax lien investing is risky. We have started by defining what tax lien investing is. You will also know about how it works. So, let’s read.
What Is A Tax Lien?
Sometimes the local government or the municipality places a legal claim on an individual’s property. They place this claim when the owner of a property fails to pay their tax debt. The notice usually starts before harsher actions, such as tax levies. The lax lien notice usually suggests that the property owner has to face some harsh actions by the IRS or local or municipal governments. This notice suggests that the IRS or the local government can eventually seize the owner’s property.
What Are Tax Lien Certificates?
When a property owner fails to pay their taxes, the local government creates a certificate called a tax lien certificate. The certificate shows the taxes that the property owner owes to the government. It also adds the different penalties and interests related to the debt. This certificate is usually auctioned off to different owners who are trying to make a profit from this.
How Do Tax Lien Certificates Work?
When a tax lien certificate is issued to a property, the municipalities can sell the tax lien certificate to private investors. The investors take care of the tax bill; in return, they have the right to collect the debt and the interest from the owner of the property. Eventually, the owners pay back their balance to the investors.
Currently, there are 29 states in the US, including Washington DC, for the assignment of collecting delinquent real estate tax liens to private organizations. National Tax Lien Association is a nonprofit organization that represents tax lien investors, services, and governments. Here is what the process of auctioning off tax lien certificates looks like.
Acquiring Tax Lien Investing Certification
When the Tax lien Investors want to buy a certificate, they have to bid in an auction. The process of how it works depends on a specific municipality.
If you are interested in tax lien investing, then you need to specialize in it. A good way to start is by familiarizing yourself with your local areas and learning how it works. This is one of the recommendations of the National Tax Lien Association for new investors.
It would also be a good option to contact the Tax official in your locality and inquire about how to collect delinquent taxes. Also, the auctions are often in-person auctions or they are done online.
Sometimes, investors need to be willing to pay a very low amount in interest rate to win the bidding. Seasoned players in tax lien investing term this method of “bidding down the interest rate.” the bidders who offer the lowest interest rate end up winning the auction. Although winning the tax lien certificate might be the case, lowering the interest rate also lowers the chances of profitability.
Balance Payment & Foreclosure Proceeding
Now the winning bidder has to pay for the tax bill and is allowed to collect foreclosure. When they are paying the tax bills, they also have to pay the delinquent debt, penalties, and interest debt.
Once the investor has acquired the tax lien certificate, they have to wait until the owner starts to pay back their debt. However, in many cases, the property owner does not pay the entire balance.
Most homeowners have what they call a redemption period in the US. The redemption period is usually three years. They are liable to pay the debt for their property within the redemption period. However, if the homeowners do not return the tax debt, the tax lien investor can start their foreclosure process. Through the foreclosure process, the investor can assume ownership of the taxed property.
Pros And Cons Of Tax Lien Investing
Here are some of the pros and cons of tax lien investing –
- Tax lien investing can allow you to earn from the interests the homeowners have to pay for their property. When winning the tax lien certificate, if you have a good interest rate, you can earn from it. But the interest rate varies from one state to the other in the US. In Florida, there is an interest rate of 18%, and in Alabama, there is an interest rate of 12%. However, if you bid down your interest during the auction, you cannot receive the rate on the lien as expected.
- Investors can passively invest in liens without the worry of attending the auction.
- When attending the auction for a tax lien, you should first do substantial research on the property and its location. It will help you decide whether tax lien investing is beneficial or not. Acquiring a tax lien certificate without prior investigation might be risky.
- As an investor, you are responsible for proceeding with the foreclosure process. However, it is a time-consuming process, and the redemption period will take you years to finally get your money or the ownership of the property.
- There is an expiry date before which you have to proceed with foreclosure or receive the debt payment.
- However, if you have a foreclosure on the property, you have to rehabilitate the property and sell it. However, this entire process can eat up whatever profit you could make from the property.
Tax lien investing has some benefits and can help you gain some profit. However, there are too many risk factors involved with this type of investment. Besides, the time taken to recover the money you paid for the property can take long. Many investors would not like to wait around for years before they can recover their money or start foreclosure.
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