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Tax Liens

Tax liens Investments

Really? That’s a popular investment for Self-Directed investors?
Also… what’s a tax lien?

Okay, first things first. A tax lien is an investment you make with a local municipality. The way it works is like this:

  1. A local municipality (e.g. a town or a city) charges a real estate tax to property owners. This tax is used to support municipal services such as schools, roads, and law enforcement. Under normal circumstances the property owner pays the tax, the town pays for its services, and everybody goes home happy.
  2. What happens if the property owner doesn’t pay his tax bill? The town suddenly finds itself in a bit of a pickle. There are services which must be provided, but there isn’t any money with which to pay for them. So the town begins to look towards alternative income streams in order to pay the bills.
  3. One of those streams is a tax lien certificate auction, or a tax liens sale. The unpaid tax is still owed to the town. As a means of guaranteeing the payment, the town places a lien on the property in the amount of the tax owed. Then the town sets up an auction where investors can bid on the tax bill. The winning bidder writes a check to the town and this money is used to replace the tax income that the town was counting on.
  4. When the property owner decides to pay the tax, he/she does so with an added penalty and the money goes to the investor. If the property owner does not pay the tax, theoretically the property could be subject to foreclosure and the investor might actually receive the property.

As funny as it may sound, the tax auctions are actually a win-win situation. The town gets the money it needs to pay for schools and other services, the property owner gets a bit of breathing room in paying off a tax bill, and the investor makes a profit on the spread that is part and parcel to loans and delayed payments.

The reason why tax liens are a popular investment is that they are virtually guaranteed. The money put out by the investor is covered by the lien on the property. And since you are taking on the local government’s position in this transaction, you get to be first in line for collections.

And, to top it all off, there’s the lottery-like incentive that the property could go into foreclosure and you could pick up a piece of real estate for next to nothing. It’s an attractive proposition for those willing to learn the business.

So what’s the downside? Like any other business, you have to know what you’re doing. Education is key. The best thing to do is to find a professional who will let you tag along and give you the lowdown on what the different numbers mean. Newbies might come into an auction and make a quick bid which is almost guaranteed to lose money. Don’t be a newbie. Do what it takes to get educated. There are people and businesses out there which will train you in for a fee, and it is okay to go that route. However, nothing compares to a one-on-one in-the-field mentor.

One other thing to keep in mind is the state-mandated auction process. Some states have switched to online auctions and this actually is to the detriment of smaller investors. The online auctions are often populated by the banks and larger institutions who are happy to go for a smaller spread and make up the difference in volume. An individual investor usually doesn’t have the war chest needed to work on volume, and thus a lot of the digital world might not be quite so appealing.

States which have in-person auctions are friendlier to smaller investors, and this is where a newcomer to tax liens should be focused.

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