Purchasing tax liens can be an attractive option for investors. If you're smart and you do your homework, tax liens can guarantee at least some return on your investment. How much you earn depends on what the property owner does after you have the lien – and whether the mortgage lender acts to protect its interest if there's a mortgage against the property.
Tax Lien Certificates
Acquiring a home through a tax lien is a two-step process, and it does not automatically follow that you'll get the home just because you get the lien. When a property owner fall behind with his property taxes, the tax collector acquires an automatic lien against his home. The collector doesn't want a lien, however. It wants its money – the unpaid taxes. Therefore, the collector sells the liens to investors at auction. It typically takes its taxes from the winning bid, and any balance over and above this amount is kept on deposit. If you're the winning bidder, the lien against the home transfers to you, but you don't yet have the home itself.
The good news about tax liens is that they take priority over almost all other liens against the property. This includes judgment liens taken by unsecured creditors and even first and second mortgages and deeds of trust. If you purchase a tax sale certificate – the paper transferring the lien to you when you win the bidding – and if you do ultimately end up with the property, only government liens such as for state or federal taxes take precedence over yours.
The second step involved in actually acquiring the home instead of just having a lien against it involves the property owner. After you have the certificate, the owner has a period of time within which to redeem it. Redeeming it involves paying the past due taxes, as well as paying you the going rate of interest for tax liens according to your state's law. If the property owner redeems the certificate – and most do – you'll get the taxes back you paid on his behalf, any balance of your bid on deposit with the tax collector, plus interest. You no longer have a lien against the property. If the property owner does not redeem the certificate within the statutory period of time, however, you get the home. In some states, the tax collector will issue you a deed for the property at the expiration of the redemption period. In others, you must participate in a second auction to win the right to buy the deed as well. In still other states, you must begin a lawsuit to judicially foreclose on the property.
If the property in question is security for a deed of trust or a mortgage, the lender most likely will not step aside and allow you to foreclose or receive a tax deed. Because the lender isn't a priority lienholder, it will lose its interest in the property if either of these things occur. Therefore, the lender must receive notice of the initial auction when the tax collector sells the certificate, as well as notice of the redemption period if the certificate is sold Typically, the lender will step in and outbid you for the certificate at the initial auction so it can protect its interests. If it doesn't do so, most states allow mortgage lenders to redeem the certificate themselves if the property owner does not do so. Either way, you'll get your money back plus interest – but you won't get the home.
Beverly Bird has been writing professionally for over 30 years. She specializes in personal finance and w, bankruptcy, and she writes as the tax expert for The Balance.