Join us as we discuss everything about Tax Liens. Tax Lien investing can be a very profitable avenue for many investors, but not all tax liens are created (or purchased) equally. It’s important to understand the different tax lien processes used, which is what we’ll be discussing in today’s episode.
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Welcome to the Tax Sale Podcast – Tax Sale Investing Made Easy.
I’m of course Casey Denman, a veteran tax sale investor and the founder of The Tax Sale Academy.
Today we’ll be discussing the tax liens. If you recall from a previous episode, the tax lien system is one of the four different types of systems used. The others are tax deed, redeemable deeds and hybrid systems.
But again, today we’re discussing tax liens. We’ll be going over what tax liens are as well as the different types of tax lien systems.
The tax lien system is used in a number of states and is one of the more common type of system used. Tax liens are sold in Arizona, Montana, Colorado, Nebraska, South Dakota, Iowa, Montana, Louisiana, Mississippi, Alabama, Illinois, Indians, Kentucky, West Virginia, Maryland, New Jersey, Rhode Island and Vermont.
As with every type of tax foreclosure system, the process always begins when the owner fails to pay their property taxes timely.
In a tax lien state, the owner is late paying their taxes. Once this happens and after a set period of time the county auctions off a lien against the property. This period of time varies from state to state.
When the tax lien auction is held an investor will purchases this lien, which is essentially a way for this investor to pay the taxes on the owner’s behalf. So for the county, they immediately receive any taxes that they were owed. The county is made whole immediately after the lien is purchased. So they’re happy, since they can meet their budgets.
In exchange for paying those taxes and buying that tax lien, the tax lien investor will earn a return on their money. As far as how much they earn, it depends on the specific state and will get into this in more detail shortly. It could be 20%, 50% or even more or could be a negative return if they purchase incorrectly.
Once an investor buys that tax lien, the defaulting or delinquent owner can still make payment of their taxes, ay addition fees, plus any interest due to the investor. They’ll have a window of time to do this and if they do pay it off, the lien will be cancelled.
Once it’s cancelled, the investor receives their investment back, usually plus interest of some sort and the property owner would then be considered current for that year’s taxes.
The taxes end up getting paid around 95% of the time. For the other 5% of the time, the taxes go unpaid.
In the event the property has a tax lien sold against it and the delinquent owner fails to pay off those taxes, fees and penalties within the allotted amount of time, the tax lien holder has the ability to become the owner of the property.
The process to gain ownership of that property can be much more complex than most people realize. Every state is just a little different, but there are two primary system utilized.
The first system is the easy system. The tax lien holder simply completes the paperwork and files it with the county. Once it is completed, reviewed and approved the property is transferred into the name of the tax lien holder’s.
In other areas, it is much more difficult. Some states view the tax lien holder as “just another lien holder.” In other words, you have a lien against the property just like a bank’s lien, city lien or mechanic’s lien. Even though your lien might be superior to the other liens that exist, it is still a lien. A lien itself does not provide ownership.
But, it does give you the ability to foreclose that lien and in some areas you’re required to pursue a full blown judicial foreclosure (like a mortgage).
What this means is that you must file the correct legal documents to foreclose your tax lien if you want to become the owner of the property. Some investors choose to handle this process themselves, while others hire attorneys to handle it for them.
Of course, the expense of this should be factored in. In fact, it should’ve been factored in PRIOR to you even making an investment in a tax lien in this area in the first place. An attorney will charge $1500 or more to foreclose any lien in most areas. So keep this in mind.
With either of these systems, once the lien has come due and isn’t paid and once you foreclose that lien or acquire ownerships pursuant to the state laws, you are the owner of the property. There is no redemption period after that point.
Then you are welcome to sell or use the property as you would any other investment.
Now, let’s take a few steps back. If you recall I said that only 5% of the tax lien properties actually get to the point of the tax lien holder obtaining ownership. This means that 95% of the properties never make it to the point of a tax lien holder obtaining ownership.
So, in this situation, where the tax lien holder does not obtain ownership, how does a tax lien holder make money?
Well, there’s a few different scenarios. But most involve interest on the investments. Let’s talk about the most commons tax lien systems that are used.
The first are overbid states. In an overbid state, an investor is buying a tax lien worth the amount of the taxes that are due. The taxes due are known as the face value of the lien. A tax lien buyer in an overbid state will usually pay more than face value to own that lien. So, for a $1,000 lien they might pay $1100. This means they bought the rights to a $1,000 by paying $1100. So there overbid amount is $100.
In an overbid state, the interest is set by state law typically. So the investor will know that the lien will earn a set amount of interest per month. Then they’ll base their maximum bid amount around that amount. So in our example where the $1,000 lien was purchased for $1100, the investor must make at least $100 in interest before the lien is redeemed or cancelled in order to break even. If the interest rate is set at 1.5% for instance, it’d take him 6 and a half months to break even.
If the lien is redeemed prior to 6 ½ months, then he’ll lose money. If it’s redeemed after 6 ½ months then he’ll make money. It’s a calculated risk. Obviously, the best case scenario is that you buy the lien for the face value, but this rarely happens in overbid states.
Something else to note, is in reference to your overbid. In our example, we had a $100 overbid. In some areas, this overbid earns interest as well. In other areas, it does not early interest. The overbid also might or might not be reimbursed depending on the area. So be sure to check on how it works where you’re at if you’re buying overbid tax liens.
If the lien isn’t redeemed in the time allowed by law, the investor would of course have the ability to foreclose that lien.
Another type of tax lien system is a bid down system. With this type of system, the investor willing to accept the lowest interest rate on their investment is the investor who will be able to purchase the lien.
What will happen is that the tax lien investor will pay the face value for the lien. The bidding starts off at the highest allowable interest rate, as set by law. From there, the lien buyers will bid that interest rate down until the bidding stops at the lowest allowable interest rate.
So for example, a lien is $1000. Bidding starts at 25% interest. One bidder bids 20%. Another bids 15% and the third bidder places the final and lowest bid of 10%. So the last bidder will pay $1000 for the lien and will receive 10% on their investment. So again, all of the investors in a bid down state will be paying the same exact amount. The difference is the amount of interest they’ll be earning.
It’s important to note in bid down states that some states will have a penalty, fee or minimum interest rate set. So the state could be a bid down state, with a minimum 2.5% fee due to the lien holder. So even if the lienholder was to bid 1%, they’d still be getting 2.5% in certain states. Just something to keep in mind.
Those are the two most popular types of tax lien auctions – overbid auctions and bid down auctions. With these two, you have lots of control and know exactly what you’re getting yourself into.
There are a couple of other types of tax lien auctions we’ll also discuss since they do exist. They are certainly more challenging types of systems for investors, and you’ll soon see why.
Ok, the first on is a random selection process. This is also referred to the lottery format. This format starts one of two ways. The first is that the property is in a bid down state and multiple buyers want to buy the lien with a 0% interest rate. Obviously, the hope here would be that the owner fails to redeem the lien. It’s pretty far fetched, but nonetheless it can happen. So when two or more bidders will accept 0% for a lien they could use the random selection or lottery format. The second way this format could be used, is as a permanent system. Basically, that’s just how the county does it – a set interest rate is offered for the lien, then they’ll use the random selection process to select the buyer.
And that’s really all there is too it. A lien comes up, the auctioneer or county randomly select someone to purchase it, that person can buy the lien or they can pass on the lien and then they sell the next lien. You are basically told what you can purchase, and there’s a chance the guy next to you gets to purchase 10 liens and you don’t have the chance to even purchase one lien. It’s completely random.
After you buy the lien that you are told you can purchase, it works just like any other tax lien. Wait the required time and if you are paid back plus your interest, if any, then you can foreclose that lien.
Another method is a round robin process. With this process, there is a set interest rate you’ll be paid as a tax lien investor. When you register you’ll be given a number. This number might be given in sequential order or randomly. The first lien will be offered to the person with the first number. The second lien will be offered to the person with the second number, so on and so forth. If you don’t want the lien you can pass it on to the next person until they find a buyer. The person in line after the buyer will receive the first opportunity to purchase the next lien. Eventually, if there are enough liens to be sold, you’ll get a chance to buy another lien.
The last type of system we’ll be discussing is thankfully becoming a fairly rare system. It’s referred to as the Ownership Bid Down process. In this process, as strange as it might sound, the person willing to accept the least percentage of ownership interest in the property, should they need to foreclose their lien, would become the winner of the lien.
Here’s how it works: Let’s say a lien is offered at $1,000. The interest rate on it would be preset and let’s say its 7%. So the first bidder will pay $1,000 for the 7% lien and 100% ownership. The second bidder would bid 80% ownership. The next bidder might bid 50% ownership.
So what would happen here is that the lien holder would hopefully have the lien that they purchased redeemed by the property owner and would earn their 7% interest back.
In the event they have to foreclose that lien, they would become whatever percentage owner that they bid. So if they bid 40% ownership and had to foreclose, they would own 40% of the property and the defaulting tax payer would own the other 60%. Then they’d have to sue for a partition sale and it really opens a huge can of worms and can get ugly.
So there you have it – all of the different types of tax lien sales. The two most popular that we discussed are overbid states and interest bid down states. These are followed by the random selection or lottery process, the round robin process and then finally the ownership bid down method.
One thing to also note here is that some municipalities or states will limit who they allow to bid and how they sell the properties. This is handled in an area by area basis. In these types of situations, large bundles of liens might be sold for millions of dollars each or they might even limit participation to institutional investors. So just something to mention.
That’s all for this episode on tax liens.
Thanks for joining me today of the Tax Sale Podcast.
As always, for more information on TS investing head to TaxSaleAcademy.com and while you’re there make sure you grab your free copy of my brand new book Tax Sale Playbook – just complete your information and let me know where to ship it!
Take care folks. Bye bye.