Investment Opportunities in the U.S.: The Risks and Rewards of Property Tax Liens

Looking for a new type of investment? Tax lien investing might just be the hottest thing going right now. Most investors aren’t aware of it, so there’s little competition and plenty of room for profit. Here’s how to stake your claim.

What Is A Property Tax Lien?

When a person neglects to pay their property tax, a local government can seize the property and sell it at auction. It’s unfortunate for the homeowner, but sometimes also for the municipality. Governments are not set up to be in the real estate business, and they often try to unload the property as quickly as possible.

Here’s where you come in. A property tax lien investment refers to the process of buying out the tax liability and then pursuing the homeowner for the back taxes. You earn an equitable interest in the property through the municipality, and the homeowner becomes your debtor.

Properties that have liens against them cannot be sold or refinanced until the taxes are repaid. Investors at a tax lien auction either bid down the interest rate on the lien or bid up the premium they’re willing to pay for it.

The investor who is willing and able to accept the lowest interest rate, or highest premium, “wins” the lien.

These types of investments are not for beginners, but they can become a nice additional (supplemental) source of investment income for the intermediate and experienced investor. And, while there are many resources out there that will teach you the basics, this website shows you everything you need for tax lien investing.

How To Make Money In Tax Liens

The profit, as it were, from a tax lien comes from the repayment made by the homeowner. You, as an investor, have simply fronted the money for the taxes. That debt can now be privatized, and you may charge interest on that debt.

Some states enforce maximum interest rates on these debts, which you must be aware of. Most states impose a maximum rate not to exceed 36 percent.

Once you take possession of a property, you must notify the homeowner that you are the new lien holder. Repayment may last up to 3 years, but may be as short as 6 months.

Benefits

One of the biggest benefits of tax lien investing is that the interest rate on your investment is typically higher than what you would get from almost any other type of traditional investment product. It’s a quasi-real estate investment, which means you have some inherent stability in the income being generated since the underlying asset has inherent value.

Since it’s a tax lien, and many homeowners are motivated to pay their taxes to keep their home, the risk can be low if you purchase high-probability (low risk) properties. In general, these are properties where the land and property value is high, taxes are reasonable or low relative to incomes, and the homeowners are motivated to keep the home.

Risks

There can be significant risk with an investment like this. For starters, there’s no guarantee that the homeowner will repay the tax lien. Once the lien is sold, the homeowner may be frustrated by the situation and walk away from the home.

You will be responsible for keeping the home intact and paying the property taxes, since you will effectively inherit the house.

This puts you in a very different role now – you’ll be the homeowner. Of course, you can still sell the house and try to recoup your investment, but you’ll be acting as a landlord or a real estate investor, instead of a tax lien investor.

If you’re not very experience with real estate investing or tax liens, these investments can be extremely risky. Tax liens are not everlasting either. There are expiration dates on the liens. If you fail to collect all of the money by the time the lien expires, you can’t recover your investment.

Finally, you’re competing against banks and hedge funds, which see these types of investments as very profitable, and a nice addition to their otherwise conservative portfolio. Sometimes, it’s difficult to outbid a bank that has superior buying and negotiation power.

Should You Do It?

The decision of whether or not to get involved in tax liens is a personal one. It will depend on your experience and knowledge of real estate, your willingness to accept the inherent risks, and the ability to collect overdue taxes from homeowners.

Some investors don’t like the idea of profiting from others’ misery. But other see tax liens as a way to help homeowners keep their home.

Ted Thomas is an investment consultant in the U.S. He enjoys sharing his experiences by posting online. You can find his articles on many investing and personal financing blogs.