One general rule in investments is that you trade risk for returns. Certificates of deposit are safe, but returns are often low. Buying a tax lien is riskier, but can deliver greater profits. Whether a CD, even with a 1 or 2 percent yield, is better than investing in a tax lien depends on your situation, your goals and your tolerance for risk.
A conventional certificate of deposit gives you a fixed rate of return for a specific time frame, such as six months, a year, three years or longer, after which you cash out. You pay a penalty if you cash out early. Several varieties of CDs exist, including a "bump up," which typically lets you get a one-time raise in interest rate if rates rise after you invest. You can buy CDs from banks and brokerages -- all it takes is having the money.
There's no point in investing $1,000 in a one-year certificate of deposit if you're going to need the cash next month. Investing in a CD commits your money until the certificate matures, so you need to decide how long you want your money tied up. Rates are another consideration. In the 1980s, for example, rates ran above 10 percent, but from 2000 to 2012 they stayed below 5.4 percent. You can shop around for the best rate but you may not find a rate that meets your investment goals.
The Tax Lien Process
When a homeowner doesn't pay property tax, local government puts a lien on the house. In 29 states the government eventually puts the liens up for auction. Whoever buys the lien can demand the tax bill, plus interest, from the owner. The owner has anywhere from a few months to three years to pay off the lien, depending on state law. If the owner doesn't pay, the lienholder takes title. Interest rates are set by state law and can run as high as 18 percent. After expenses, however, the returns usually amount to 4 to 7 percent.
Tax Lien Factors
Tax-lien advisers sometimes brag about buying a $200,000 house by bidding a few thousand at a lien auction. Almost all homeowners pay off their lien, though, so you're more likely to end up with interest on your investment than real estate. Even if the rate of return is better than current CD rates, you'll have to work for it. You have to research the properties you bid on, to know they'll be worth the money if you do take ownership. You also need to watch for new tax-lien auctions on the property during the redemption period. If you don't bid on them, the winning bidder can challenge your claim to the house.
Video of the Day
- Wall Street Journal: What Is a Certificate of Deposit (CD)?
- Bankrate: Buying a Home in a Tax Lien Sale
- Wall Street Journal: How to Invest in a Certificate of Deposit (CD)?
- Forbes: Vulture Investing -- What You Need to Know Before Bidding for Tax Liens
- Taxforeclosuresales.com: Tax Lien Certificate State Profiles
- Bankrate: CD Rates History | 1984-2012
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