Tax Lien Investing

Last time we discussed short sales.  Briefly, today I want to discuss tax liens with a future discussion regarding tax deeds.

A tax lien is a claim attached to any piece of real or personal property for the satisfaction of some debt or duty.  Pretty confusing huh!  What it means is that someone didn’t pay their property taxes and now the government is after them!  As usual that isn’t a good thing. 

What’s bad for the neglectful tax-payer is good for the tax lien investor.  Here’s why:  These tax lien certificates are sold by the local counties to investors.  What do the real estate investors do with them?  Well, they hold onto them until either one of two things happen.  First thing that can happen is that the negligent homeowner pays the county the back taxes along with fees and interest.  The second thing that can happen is that the homeowner doesn’t pay the back taxes and the owner of the tax lien forecloses and takes the property free and clear.

Did you get that?  Free and clear, meaning that even if there was a mortgage it is now history and you have a house for the price of one year’s worth of back taxes.  As you can probably guess, that doesn’t happen all that often.  As the bank understands this rule they will typically step in if the homeowner doesn’t pay.

That leaves scenario B.  In this case the homeowner pays back taxes, fees and interest.  The interest rate varies from state to state (even county to county) and often the investor has the opportunity to bid on the interest amount that they will receive when purchasing the tax lien.  However, typically, the lien returns a high rate of interest.  In Arizona the rate is 16% (although that rate can be bid down by competing investors).  Meaning that if you know what you are doing – or you hire someone who knows what they are doing, it is pretty easy to return virtual risk free double digit returns on your money through tax liens.  Additionally, the more you participate the more likely it is that you will hit a home run of obtaining a house simply by purchasing a tax lien at your local county auction.

I suppose I should qualify the above statement that the investment is virtually risk free.  It is, of course, not risk free.  There are always risks in any investment.  The big difference in tax lien investing is that, contrary to the stock market, the investor controls the vast majority of the risk by choosing the correct type of property and following the county procedures.  In future posts I will discuss some of the specific ways to avoid risk in this investment niche.