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What is a tax lien certificate?

There are basically two types of states in the US.  Deed states and Lien states.  Most investors are very familiar with how a Deed State operates, and most are very unfamiliar with Lien States, and Tax Lien Certificates.

In a Deed state, when a property owner does not pay their property taxes, the County tax collector forecloses on the property, and conducts an auction, sometimes referred to as a tax sale.  At the tax foreclosure auction, the bidders are bidding on the full price of the property, and the high bidder receives a Tax Deed from the County.  In this instance, the county has foreclosed on the property and deeded it to the buyer.  Frequently, in deed states, five to seven years have elapsed from the time that a property has become delinquent, to the time that the County actually forecloses and sells the property at auction.

Lien states are very different.  Instead of waiting several years to receive their past-due taxes, in a lien state, the county tax collector holds an annual tax lien certificate sale.  At the sale, the County allows bidders to pay the delinquent taxes on behalf of the property owner.  In exchange, the winning bidder has now purchased the county’s lien on the property.  If the property owner later decides to pay their property taxes, they owe the original amount of their delinquent tax, plus interest that has accrued on the tax lien.  Because the bidder/investor purchased the lien, the investor receives their original investment back, plus interest.  If the property owner chooses not to pay their property taxes, the investor has the right to foreclose the tax lien.  When an investor forecloses on a tax lien certificate, the investor is eligible to obtain ownership of the property through the foreclosure process.  Via tax liens, the County is able to receive their delinquent property taxes relatively quickly (compared with a Deed state), instead of waiting years for the revenue they need to fund their operations.

What position is a tax lien generally in?

A tax lien certificate is a certificate of claim against a property, generally in first lien position.  This means that a tax lien is superior to mortgages, Deeds of Trust, judgments, garnishments, etc.  With a few exceptions, nothing is placed ahead of a tax lien certificate, and as a result, when an investor forecloses a tax lien, the property is typically conveyed to the investor free of any liens or encumbrances (typically referred to as “free and clear”).

How much interest does a tax lien certificate pay?

The maximum allowed interest an investor can collect on the tax lien is usually set by the state legislature.  Therefore, it varies widely from state to state, but it can be anywhere from the low single digits, all the way to 36%.  Each state is different, but typically, the rate paid on a tax lien is determined at the tax lien auction.  Tax lien auctions are frequently Dutch Auctions, where the investor bids on the interest rate.  The bidding starts high, and investors bid down the rate, until no bidders are willing to bid any lower.  So the bidding might start at 16%, and the rate would continue to be bid down, ending at 8%, when no investor is willing to accept a rate less than 8% for that specific lien.

What are the risks with purchasing tax lien certificates?

As with any investment, there are some risks involved with purchasing tax lien certificates.  An investment in tax liens is less liquid than many traditional investments, because the investor must wait for the property owner to either pay their property taxes, or the investor must wait until they can foreclose the lien.  However, when compared to other investment vehicles on the market, tax lien certificates are considered to be some of the lowest risk investments.  One of the main reasons they are considered low risk is that they are usually in the first lien position.  Our fund documents provide more details on tax lien investing.  Be sure to read them carefully, and obtain your own legal or tax advice before investing.