Are Tax Liens Risky?

Investing in tax liens can expose your portfolio to real estate, even if you don’t own property. However, the process can be complex, and novice investors risk losing money. Investing in a tax lien certificate can be risky, so here’s what you should know about it.

Tax liens: what are they?

When property taxes are not paid, a local or municipal government may place a tax lien on the property. Generally, the notice precedes harsher actions, such as a tax levy, where the IRS or a local government can seize property.

Here’s how tax lien investing works:

Suppose a municipality issues a tax lien to a property owner past due on their taxes. In that case, they create a tax lien certificate, which identifies how much taxes are due along with interest and penalties.

Municipalities can then sell the certificates to private investors to recover delinquent tax dollars. These investors take care of the tax bill in exchange for the right to collect that money, plus interest, from the property owners.

The National Tax Lien Association, which represents governments, institutional investors, and servicers, reports that 28 states allow the transfer of delinquent real estate tax liens to the private sector.

 The process looks like this:

1. An auction is held for the tax lien to be purchased by investors.

Municipalities determine how the auction process works for tax lien investors. According to the National Tax Lien Association, prospective investors should familiarize themselves with the local area before investing. Contact local tax officials to identify how delinquent taxes are collected in your area.

There are both online and live auctions. Investors sometimes win auctions if they offer the lowest interest rate, a process known as “bidding down the interest rate.” Municipalities set a maximum interest rate, and the lowest bidder below that rate wins the auction. Remember, however, that profits fall as interest rates fall.

Other winning bids are awarded to those who pay the highest cash amount above the lien amount.

2. Upon winning the bid, the winning bidder pays the balance and handles the foreclosure process

The winning bidder must pay the entire tax bill, including the delinquent debt, interest, and penalties. After that, the investor must wait for the property owners to pay back their entire balance unless they refuse.

Homeowners generally have a redemption period of one to three years before paying their taxes plus interest. The tax lien investor, however, will kickstart the foreclosure process if the homeowner fails to return the tax debt, which would allow them to take over the property.

You must also learn your responsibilities if you win a lien at auction. For example, in Illinois, tax lien investors need to notify property owners within four months that they own liens and have the right to foreclose if they do not repay, says Joanne Musa, owner of You must send a second letter to the property owners before the redemption period expires.

Tax lien investing: benefits and risks

Before investing in tax liens, experts recommend weighing the risks carefully. In the worst-case scenario, complicated rules and loopholes can lead to hefty losses for some investors.

  1. Investments in tax liens can yield a higher return but not always.

The interest rate of the tax lien is what most investors depend on to make money. Rates vary by state and jurisdiction. Among the states with statutory interest rates, Arizona has 16 percent, Florida has 18 percent, and Alabama has 12 percent, according to the National Tax Lien Association.

During the bidding process, profits do not always equal high yields. The National Tax Lien Association’s Brad Westover states that tax liens are generally sold between 3 percent and 7 percent at auction.

  • There is an expiration date for tax liens.

If the property owner does not pay the property taxes by the end of the redemption period, the lienholder may initiate foreclosure proceedings to take ownership of the property. Foreclosures rarely occur: tax payments are usually made before redemption. The first lien to be repaid is usually the tax lien; these liens get paid before the mortgage.

Nevertheless, tax liens have an expiration date, and the lienholder’s right to foreclose on the property or collect their investment expires along with it.

When you buy a lien on a property, you may also want to pay taxes in the following years, so no one else can purchase a lien and claim ownership.

  • Research is essential when investing in tax liens.

Before making any investment in tax liens, individuals should do their homework. It is suggested that you avoid environmental damage properties, such as when a gas station dumps hazardous materials. Because if the property goes into foreclosure, you would own it.

In addition, investors should examine the property and all liens against it, as well as recent tax sales and similar property prices. In the event of foreclosure, obtaining the property’s title might be harder if it has other liens.

In summary

Tax lien investing involves so much due diligence that you might want to consider investing passively through an institutional investor member of the National Tax Lien Association. For a beginner, that might make managing the process easier.

Investing in tax liens can provide a generous return, but be aware of the fine print, details, and rules.