What Are Tax Liens and How To Make Money From Tax Lien Investing

Updated: Dec 28, 2021

In order to stay ahead of inflation, investors are constantly looking for safe investments.

Especially with the low interest rates we’ve experienced in 2021. But what if you heard from a reliable source that a particular investment could all but guarantee an 18% return? Would that get your attention?

You might be thinking, “There’s no way you can guarantee a high return rate like that without an equally high risk.” Normally that’s true. But this is an exception. And the data proves it.

We’re talking about tax lien investing.

You could say that tax lien investing is under the radar. That’s because it’s still underused by investors in general and it’s been around for over 200 years!

It’s likely that a reason why it’s underused is that the word tax is a bit off-putting. Sure, you can’t escape paying taxes. But one of the great things about tax lien investing is that it takes advantage of that fact.

It simply acknowledges that there will always be people who can’t afford their property taxes. And when it comes to taxes, the government will always get what it says it deserves.

Investing in this fact through tax lien certificates offers an interest rate that is basically guaranteed. There are some people out there who have caught on to this fact.

For decades, institutional investors and family offices have been investing in tax liens with billions of dollars. Billions. But is tax lien investing right for you?

Learn the basics of tax lien investing

Anyone can learn tax lien investing

Whether you own a home or not, property tax is something you’re at least mildly familiar with.

If you own property, the government taxes it.

Pretty simple, right?

Property tax is separate from sales tax and income tax. If you own a home, you have a mortgage. When you pay your mortgage every month, it’s likely some of that money goes toward your property tax.

This is done by the lender who holds your money in escrow. That’s how most people have it set up. Whether or not you know the amount of property tax you pay each month, you’re paying it.

There isn’t a county in the US that doesn’t collect property tax.

Not every property is assessed the same tax dollar amount.

The amount differs property to property. Amounts are based on a few things, mostly features and location.

Before you officially buy a property, a representative will complete a tax assessment. This determines how much you pay.

Some states have different rates, but all rates are calculated as a percentage of the property’s value.

Property tax is low in the state of Hawaii, for example (lower than 0.3%. However, in New Jersey, it’s higher than 2%. It simply depends on where you live.

The average property tax is 1.5%. The Census Bureau says that the average residential property in America is taxed about $2,100 each year.

Just a bit more on property tax before we get to tax liens

When you pay you’re property tax, you’re paying it directly to the county. They’re the ones who collect it. If a person fails to pay their property tax, the property then has a lien against it.

The tax lien is always in the amount of tax owed.

So a lien is sort of like an IOU, in a way.

The problem is that the county has their projects for that year all budgeted out. When a county has lots of liens, that means there’s large amounts of money they haven’t received.

Money they were expecting to have to pay for things they’ve budgeted for.

So, as you can see, local governments don’t like liens all that much.

It means less money for them in the moment and may require lots of time to try and sell them.

What are tax Lien Certificate

What do counties do with all these liens? In an effort to collect as much of these unpaid property taxes as possible, they hold an auction.

The auction is an attempt to sell as many of these liens as they can to the public. Any citizen can attend such an auction as an investor.

When liens are presented at these auctions, they are referred to as tax lien certificates.

Investing in tax liens is easy

Do you need a real estate license to invest in tax liens? Nope.

Do you need to set up an LLC? Nope.

Do you need lots of money? Nope.

When you buy a tax lien, the homeowner is giving you a certificate in exchange for paying their property taxes.

The certificate is not a deed.

It’s good for the amount you paid plus interest.

And guess what else? Your certificate (which can now be called an investment) is backed by collateral.

The collateral is the state law and the property law. These laws guarantee you, as investor of the tax lien, interest.

You’ve paid the back taxes. Now you will receive an interest rate that is guaranteed.

And we haven’t even mentioned that tax lien investments have no secondary market and they’re negotiable instruments. When you buy a tax lien certificate, you earn interest on that property.

The certificate is a legal and enforceable obligation. It guarantees that if the property forecloses, you are the first debt obligation to be paid.

What I am actually getting with a tax lien certificate?

Remember that you’re not buying a property when you buy a tax lien certificate.

You’re paying the past-due property taxes.

You never have to deal with the owner of the property. When the home owner does finally pay the taxes, you get the late fees and interest rate.

What happens if the home owner ends up not paying the property taxes? The house will foreclose.

If this happens, all the fees, penalties, back taxes, and title become yours.

So essentially, you as the tax lien investor experience one of two different outcomes.

(1) You get a secured high-interest rate because the tax lien certificate is redeemed.

(2) You get the property through foreclosure because the tax lien certificate is not redeemed.

It’s common for the second option to happen for very little money.

And one outcome isn’t necessarily better than the other. It simply depends on what your investing goals are.

You always get a fixed interest rate with a tax lien.

Depending on the county, the rate can differ slightly.

For example, the current (as of the fall of 2019) annual interest rate in Baltimore is almost 20%. However, the annual rate in many Illinois counties is over 35%. It’s not surprising that a lot of attention is given to these high interest rates.

Tax liens are a great investment for people with a $100 per property budget or $100,000 per property.

How much can you invest with tax liens?

There’s no limit. Investing in tax liens has no cap.

You can invest as much or as little as you want.

There are no FDIC-regulated limits.

When you secure a tax lien certificate, the property still belongs to the property owner.

The way it works is the court allows them to pay off the lien. That is, until the judge says it’s time to foreclose. The court will tell you, the holder of the tax lien certificate, that foreclosure must happen by a certain date.

If the property owner doesn’t redeem by then, the foreclosure process must begin.

The average time period for this is two years.

By the way, you forfeit your investment if you don’t begin the foreclosure process by the designated date.

If this happens, you won’t get a refund.

How do you buy for a tax lien certificate?