Hey there it’s Casey Denman here with TaxSaleAcademy.com. Thanks so much for joining me for our weekly question segment.
This week’s question comes to us from JMC. JMC asks, Why would anyone want to buy a tax lien at a 1 or 2% interest rate?
So, um, JMC thanks for submitting your question. So what they’re talking about is the interest rate on the tax lien. So when a property owner is delinquent, the county, in some states will sell a tax lien. That is a priority lien against the parcel of real state that will be purchased by a tax lien investor who looks to earn interest on their money. If the owner of the property fails to redeem the lien in the redemption window, the tax lien holder can foreclose the lien and become the owner of the property.
Now, there are a number of different tax lien systems that exist. Some areas will do a premium bid method where you’ll bid more than face value in exchange for the lien. In other areas, and what I’m assuming JMC is referring to are the areas where a tax liens interest rate will start off at the maximum allowable by law which could be 16 or 18%. From there, it’s auctioned off kind of in reverse order as the interest rate gets lower and lower. Whoever accepts the lowest interest rate for that lien will be the winning bidder.
Most of the time, these rates will be just about any other investments. In some situations, however, you’ll see liens sold at very low interest rates. I’ve even seen many sold at a 0% interest rate before, which, at face value, means they should earn 0% on their money. So why on earth would someone do this? Why let your money sit for free, right?
There are 3 primary reasons.
The first is what most people think about, but is actually the least likely. You could buy a lien at 0 or 1% interest or some nominal amount in hopes that you get the property. So in exchange for letting your money sit while earning virtually nothing, in a couple of years you might become the property owner if the lien does not get redeemed. And then you can make quite a bit of money. While this can work if you do it enough times, the stats say that the majority, well over 90% of all tax liens end up getting redeemed. Nonetheless, some people do try this method.
Secondly, is to have the ability to buy a subsequent tax lien. So in some states, if there are any existing tax liens, that tax lien holder has the first option to buy subsequent tax liens. The subsequent tax liens, in some states, will be at the state maximum interest rate. So what could happen is you bid 0% interest. Year one passes and the owner doesn’t pay their taxes for another year. So you buy the second year tax lien and get the state max of say 18%. At the end of year two, when they redeem your return will be an average or 9% per year, which is the 18% in year two divided by both years. With that said, if they redeem anytime prior to month 12 you’ve just loaned someone your money for free. If they redeem in month 13, then you’ve earned ¾ of 1%. So, as you can see it’s certainly a calculated gamble.
The last reason someone would invest at such a low rate is to earn the penalty fee. In some areas, there will be a penalty paid to the investor on top of the interest rate. So, you might bid 0% on the lien, but you could get a 5% penalty fee, for example. In this case, if the property owner redeems very quickly you’ll have done quite well. If it takes them 2 years to redeem then you’ll have earned 2.5% per year on your money. But this is popular in some areas, especially for the tax lien investors who are able to spot the properties that will redeem very soon after the sale.
So, JMC, hopefully this answers your question and helps put a little context behind other investor’s bids. If you have a followup question or anyone else watching this video has a question feel free to leave it below this video or any of our videos here on YouTube.
Don’t forget to check out all the links in today’s video description for lots of helpful ways to learn about this incredible business. One of those links will take you to TaxSaleAcademy.com where you can grab your copy of my free book, Tax Sale Playbook, if you just cover shipping OR you can join the academy for the most advanced step by step training we offer.
Take care and make it a successful day. See ya next time!