You may have heard of tax lien investing, but you’re not sure what it is, exactly. Perhaps you’ve heard that tax lien investing is a smart investment that requires low capital, and if you’ve heard that, you’re right.
There are several ways to invest in real estate. Tax lien investing is one of the ways that requires low capital, but can garner a good return.
Tax lien investing is the process of purchasing tax lien certificates as an investment. When a homeowner fails to pay their property taxes, a lien against their property for the tax debt owed. A lien prevents a homeowner from selling their property or refinancing it, until the taxes are paid.
If you purchase tax lien certificates, you can earn a return by collecting interest on the homeowner’s initial tax lien purchase. In essence, you become a short-term lender, waiting to get your money back plus interest.
There are billions of dollars of unpaid property taxes every year, due to delinquent property owners all around the world. This creates a lot of opportunities for tax lien investing.
Purchasing tax lien certificates can be as low-cost as just a couple hundred or a couple thousand dollars.
Tax lien investing has been around for over 200 years, and is a tried-and-true type of investing that has stood the test of time.
It’s important to understand the rules and regulations of tax lien investing before you choose this method of investment. The rules and regulations vary depending on where you live. For this reason, it’s important to do very targeted research on your region’s regulations.
How Does Tax Lien Investing Work?
Let’s discuss how tax lien investing works, in a general sense. First of all, tax liens are tax debts that can be purchased investment purposes, to collect the interest. By purchasing tax lien certificates, you are now the lien holder, and that allows you to pay the homeowner’s tax bill. In exchange for taking care of the homeowner’s debt, you are allowed to collect interest on the outstanding debt.
If you are interested in tax lien investing, you will have to decide what the lowest interest rate you’ll accept is, for a particular tax lien certificate, before you purchase it.
Different regions have different interest rate ceilings on tax lien certificates. In other words, there is a certain maximum interest rate that you can earn. You could earn up to an 18% return or higher, however, which is quite profitable. Even if your return was only 6%, that interest rate is still quite profitable.
When a homeowner pays the delinquent property taxes to the county, they will also have to pay interest to you, the owner of the tax lien certificate.
Tax Lien Investing is a Much Cheaper Alternative to Investing in Real Estate
Investing in real estate is very expensive. You need to have a lot of money for a down payment, and money for the monthly mortgage payments.
People who are interested in investing in real estate but can’t afford this expensive investment could try tax lien investing instead.
If you’re interested in real estate, you’ll probably be interested in tax lien investing.
The time frame for tax lien investing is between six months and three years, which means you likely won’t be waiting that long to get your money back (plus your profits).
What Exactly Are Property Taxes?
You can’t own a home without paying property taxes. Property taxes provide funds necessary for the good of the community your home is located in. For example, your community’s schools, public libraries, community centers, road repairs, snow removal, police protection and fire protection are funded by property taxes.
Property taxes also pay for things like garbage removal, hospitals, and park maintenance.
According to the U.S. Census Bureau, the average American household spends $2,149 on property taxes for their homes each year. Property tax is assessed based on the value of ones’ property.
The reason why tax lien certificates are sold is because the government needs to fund the community services of police protection, fire protection, road construction and maintenance, garbage removal, etc. They can’t wait for delinquent homeowners to pay. These funds are needed now for the good of the community.
Tax Lien Investing Can Lead to Low-Cost Ownership of Property
Guess what? If a homeowner fails to redeem their property taxes within the allotted redemption period, the owner of the tax lien certificate can foreclose on the property. Do you know what this means? If you are the lien holder, you could potentially take ownership of a property for just pennies on the dollar or just a few thousand dollars.
Don’t get too excited, yet. Understand that you’ll probably only end up with the profits from collecting interest on the homeowner’s debt. Foreclosure is rare. It’s also very time-consuming and the process can take years.
This process also typically requires legal counsel, which you’ll have to pay for. Other costs of acquiring property include large and costly projects and home repairs. This includes electrical work, roofing, plumbing, and caring for the property.
That’s why many people involved with tax lien investing choose to stick with simply looking forward to earning the profits from collecting the interest.
It’s still important to understand all potential outcomes, though. I always say, “Investigate before you invest.” Understand the two most common potential outcomes of tax lien investing. Either your tax lien certificate is redeemed and you earn interest, or the tax lien certificate is not redeemed and you can acquire the property through foreclosure. Know that you could acquire a worthless property. That’s why you need to prevent that happening by doing research and investigating.
If the homeowner quickly pays off their taxes, you collect a lesser interest rate, which is another outcome you should be aware of.
How Do You Invest in Tax Lien Certificates?
Most counties hold a tax lien sale at least once per year. These auctions often take place online. This means that you simply pay a small registration fee online (perhaps $100) and then bid via an online form.
You bid on the tax lien certificates that interest you.
You’re bidding online, but there’s a feel of a live auction.
When multiple bidders want the same tax certificate, they often bid down the interest. For example, if a bidder is willing to accept 8 percent interest, that person bids it down to “8.” If another bidder is willing to accept lower interest, that person bids “7”. This continues until no bidders are willing to go lower.
But how do you know which properties to bid on in the first place?
There might be hundreds of properties available to bid on. You need to figure out how to decide what to bid on.
The best way to narrow it down, is to eliminate the ones that don’t fit your budget or investing criteria. If you have only a few thousand dollars to invest, then what? You can immediately eliminate the properties with minimum bids that exceed your budget.
Another investment criteria to decide on before you start bidding is, what outcome are you hoping for? If you don’t want to acquire a property through foreclosure, and you don’t hope for that outcome, then bid on tax liens that have a high likelihood at being redeemed. A family with a mortgage is more likely to redeem and less likely to foreclose.
If acquiring property is an outcome of the investment that does interest you, be careful which properties you bid on. Do your research on the property and neighborhood. You don’t want to get stuck with a worthless property that has no potential.
It’s Crucial to Do Your Research on Tax Lien Investing, and Learn From Someone With Experience
If you fail to do your research, or you fail to understand the rules and regulations of tax lien investing, you could risk losing money.
For example, it requires research to find the best deals, the best properties, and know which tax lien certificates to buy. You also have certain responsibilities as a lien holder that you need to ensure you understand before trying out this method of investing.
Some of these responsibilities include keeping track of deadlines, filing paperwork on time, and other administrative duties.
Since the lien holder is responsible for paying the property taxes, failing to do so could result in another investor purchasing the delinquent taxes from under you.
Do your research, and talk to an expert who has experience with tax lien investing, or an expert investor.
If you know of someone who lost money in tax lien investing, don’t be naive enough to think it’ll be different for you. It could be different for you, but only if you do a lot of research. And only if you’re smart about what you bid on. Talk to a mentor. One of the greatest investors of all time, Sir John Templeton, said, “The four most dangerous words in investing are: This time it’s different.”
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