Property Taxes
Before we dive into the details of tax liens and tax deeds, I wanted to go over a few key points regarding property taxes. In the U.S., aside from federal, state and taxes on goods and services, we pay property taxes.
Regardless if you have a mortgage or your home is paid in full, you are required by law to pay property taxes every year. There is no way around it if you want to keep your property. This is a very important point, because if you ever stop paying property taxes, the county can seize your property by putting a lien or deed on it.
Property taxes in most counties are the main source of revenue, which allows the counties to pay for services such as schools, police, road maintenance, and support local initiatives. For these reasons, the state laws have enabled the counties to collect property taxes in order to be able to keep these services operational.
Even though people are obligated to pay property taxes, often times counties deal with the issue of people not paying on time or not paying at all. There are a number of reasons why people don’t pay property taxes. I don’t intend to list them all here, but the most common ones are a lack of money, laziness, forgot tax due date, family dispute, and inheritance.
In order for every county to protect themselves and to ensure services are running as they are supposed to, the state has set up a law that protects the local counties from property owners who do not pay property taxes. That law is in the form of a tax liens or tax deeds.
Tax Liens
If property owner does not pay their property taxes, the county issues a lien against the property and mark the property as delinquent. To put things to perspective, if you owe $1,000 in property taxes, the county is going to issue a lien for $1,000 and sell it at auction to real estate investors. I know what you are thinking; why would the county issue a lien if they can foreclose on the property? The county wants their money right away for reasons listed above, not after foreclosure of when the property sells.
Going back to the auction scenario, when a lien is auctioned there is an administrative cost of at least 10% on top of the auction price. In our case, if the lien is auctioned for $7,000, the winning bidder pays the county a total of $7,700. When liens are auctioned, anyone can buy these liens as long as they feel comfortable with the price and are ready to pay right away. In case liens do not sell at auction, they become available at the county treasurers’s office at even a lower price.
Here comes the best part. Once you pay the auction price plus the administrative fees, you get a tax lien certificate, which allows you to collect interest on the property until the redemption period is up or foreclosure takes place. Depending on the state, the interest rate is usually very high. For example in the state of Maryland, the interest rate very between 6% to 24% and the redemption period is between 6 months to 2 years. In case the property owner does not pay their taxes back to the county before the redemption period is up, you the tax lien holder, can legally take ownership of the property by foreclosing on it.
Foreclosure Types
If a property owner does not pay their taxes back to the county before the redemption period is up, the state will mandate foreclosure.
In this post, I’m going to discuss judicial foreclosures and non judicial foreclosures.
Judicial Foreclosure
As indicated by the title, these are court ordered foreclosures usually end with auctioning the property. Once a lawsuit is filed by the bank or private lender, and the judge makes the final decision, the property is marked as foreclosed and future sale date is set in motion. This information is publicly available letting others know the current state of the property.
Non Judicial Foreclosure
You guessed it, these foreclosures are initiated by the bank or private lender without the need to start a court process. When mortgage contracts are issued, the bank specifies the terms and conditions in the event the home owner fails to keep up with their monthly payments.
As a tax lien certificate investor, you want to make sure you steer clear of foreclosed property, because it can take months or years before you get your money back.
Redemption Periods
Redemption period is defied as period when the property owner has the right to reclaim the property after a lien has been issued. In other words, the property owner has to pay back their property taxes to the county before the investor (lien holder) starts a foreclosure process.
Each state sets its own laws. For instance, in Maryland the redemption period varies from 6 months to 2 years. During the redemption period, the property owner can pay back their taxes and avoid foreclosure. As a tax lien certificate investor, you have to wait 6 months to 2 years, before you can start the foreclosure process.
Either way, if property taxes are payed before the redemption period is up or if property taxes are not payed at all, the tax lien certificate holder get their investment back with interest. Again, the interest rates vary for each state.
As tax lien certificate holder you are entitled to collect interest, to foreclose on property after redemption period is up, and get paid first when foreclosure takes place. When property is sold or foreclosed, even before the mortgage company get their money back, you are paid with interest first.
On the flip side, before you buy a tax lien certificate you do not have the right to physically inspect the property. Therefore, your options are limited to driving by the neighborhood, asking neighbors about the property, or researching the property online.
Bidding Approach
When bidding on tax liens, you’re most likely to encounter two options, bidding the rates down or bidding the price of the liens up.
With this approach, the interest rate of the lien is dropped to a certain rate before the lien is sold. For instance, in Maryland a lien can be auctioned at 24% interest rate, as the auction goes on, the auctioneer gradually drops the rate until someone is willing to buy a lien at lower interest rate of let’s say, 6%. This is just and example of bidding the interest rate down and the actual rates may very.
Who would sign up for such a deal? Well if you knew the subsequent years would bring you a higher interest rate on the lien you are bidding on, you would be ok with bidding the interest rate down. To give you an example, let’s say you buy a lien with 0% interest for the first year, the following years the interest rate is 36%. On average you are expected to receive a 24% interest for 3 years holding period.
With the latter approach, the price of the lien goes up. In this case, flat interest rate is introduced during the bidding process. This approach is not any different than bidding on eBay. The price of the lien goes up while the interest rate remains the same as the auctioneer solicits bids and the maximum bid is reached.
This approached is favored by investors who are looking to foreclose on a property or know the property will be foreclosed. Knowing they paid little money to buy a tax lien certificate, post redemption period, they can end up owning a property, which has much higher value then the money put forth buying the tax lien certificate.
In many states, some properties do not get sold at auction, and counties offer what’s called over the counter tax lien certificate sales. At this after auction sales, the counties offer tax lien certificates to anyone willing to pay the back taxes, interest, and any administrative fees. There is no bidding involved. Therefore, you have zero competition, but you have to remember, these over the counter sales are based on first come first serve basis.
Tax Deeds
A deed on a property is issued to a new owner, after the old owner lost the property by not paying property taxes, which resulted in foreclosure.
The difference between tax lien certificates and tax deeds is that in the tax deed situation, the actual property is being sold at the auction, which means the property has already been foreclosed on. In a nutshell, an investor attends an auction, pays for the property as final bidder, and becomes a new owner of the property.
Redemption Period
When dealing with tax deeds, the redemption period allows the property owner to pay back property taxes in full and prevent major action taken agains their property. By major action, I mean county initiating a foreclosure on the property or property being auctioned off.
During the redemption period, if the property owner is to avoid foreclosure from being initiated by the county, he/she must pay back property taxes plus all other legal fees.
Even if the property is auctioned off, the property owner has the right to pay back property taxes and all legal fees before the auction takes place. Some states are more generous than the other so be sure to do your homework to get full understanding of tax deed redemption requirements.
Bidding Approach
During a tax deed auction, the starting bid is based on the property taxes owed plus all legal fees added up together. Other states start the bidding process at a percentage of the property market value.
These auctions are open to the public and often held on-site or through various online platforms. Some states avoid the auction all together and offer the property directly to a buyer literally at the”front steps” of the property being auctioned off. As with the tax lien certificates, you can turn to your local treasurer’s office or website for more information on sale location, time, date, and so on.
In almost all bidding scenarios, the serious bidders are required to put down a deposit to ensure they have adequate amount of money in case they become the winning bidder.
If you are the winning bidder, you are required to put down an additional deposit or even pay the full balance on the property right after the bidding is over. This process may very for each state, however it is important for the investor to know the exact amount of funds needed to acquired the property before attending the auction.
Another point to keep in mind, is that you can not physically inspect the property prior to bidding. That is why is very important for you to do your due diligence and have a general idea of the condition of the property.
A typical sale or auction of tax deed involves the owner, the county, the bidder, and occasionally the lien-holder.
Bottom Line
Even though it is a fairly simple process to acquire tax liens and tax deeds, you should always do your homework on every bid you consider making. It is of vital importance you become familiar with local county rules and regulations so that you are better position for success and can make more informed decisions.
The bottom line is to drive your ROI upwards as you are cashing in on the opportunities offered by tax liens and deeds. To me, this is one of the simplest and most lucrative ways to real estate investing.
