What are Tax Lien Certificates - A Basic Introduction to Real Estate Tax Liens.
Tax lien certificates have been around for over 200 years. In fact, every year investors and banks spend billion of dollars buying tax lien certificates. They've also done their very best to keep the tax lien business to themselves.
As a result, tax lien certificates are virtually unknown to all except a small percentage of the world's wealthiest investors. 
Which is why tax lien certificates have attracted the attention of some of the biggest banks and hedge funds in the country including Bank of America, JPMorgan Chase, and Fortress Investment Group.
Here's how the tax lien certificate business works.
In the conventional mortgage market, lenders typically insist that an escrow account be set up to cover the costs of real estate property taxes and mortgage insurance. However, the vast majority of subprime and stated income mortgage loans do not include an escrow account.
Some lenders and mortgage brokers used the lower monthly loan payment amount without escrow to lure consumers into believing that the loans were more affordable.
Many homeowners wrongly assumed the new loan would also have an escrow account and did not know that they would be responsible for making tax payments directly to the local municipality.
As a result of the subprime mortgage meltdown, thousands of counties all across the United States have millions of dollars in outstanding property taxes. Communities rely on the revenue generated from property taxes to fund daily services.
Unpaid real estate taxes creates a serious cash-flow problem for communities.
If local governments are unable to collect real estate property taxes, they are also unable to fund important government services like police protection, public schooling, and emergency medical services.
Recently, The National Tax Lien Association reported that annual property tax delinquencies are on the rise and total approximately $15 billion nationwide.
Politicians find themselves in a difficult situation, raising property taxes isn't popular and could mean losing an election. The failure to collect on these past-due debts weighs heavily on their already-overburdened budgets.
Across the United States cash-strapped communities turn to investors for help.
To solve this cash-flow problem, local governments allow investors to pay off a portion of these delinquent property taxes. In return, investors receive a tax lien certificate which is a claim for property taxes.
Currently, tax lien certificates are sold in the following states:
Alabama, Arizona, Colorado, District of Columbia, Florida, Illinois, Indiana, Iowa, Kentucky, Maryland, Mississippi, Missouri, Montana, Nebraska, New Jersey, New York (City), Ohio, Oklahoma, Puerto Rico, South Carolina, South Dakota, Vermont, West Virginia, Wyoming.
The sale of tax lien certificates helps cities and communities. The funds collected from the sale of these tax lien certificates generates the much needed revenue cities and communities need to pay for essential services.
An estimated $7 to $10 billion worth of tax lien certificates are sold each year.
Investors buy tax lien certificates at delinquent property tax sale auctions. A tax lien certificate transfers all the rights that come with being the owner of the real estate tax lien from the government to the investor.
Tax lien certificate investors effectively own a claim against the property until the property owner pays the county or municipality back.
A growing number of counties and municipalities conduct their delinquent property tax sale auctions online making it possible to purchase tax lien certificates from the comfort of home.
Many taxing districts sell tax lien certificates through the mail or over-the-counter.
With a lot of investments it takes a great deal of money to get started but this is simply not the case with tax lien certificates.
County governments and municipalities sell tax lien certificates on all types of properties. I've seen them range from as little as $6 at the low end to several million at the high end.
The sale of tax lien certificates is a tremendous help to our communities.
When a taxing district sells tax lien certificates they use the collected funds to pay delinquent property taxes. The sale of tax lien certificates transfers the governments rights to the purchaser. Including the right to receive all of the tax money due - including fees, high interest, and penalties.
To encourage tax-delinquent property owners to pay their past-due property taxes, the county charges them interest and/or penalties (think of it like a late fee), which is passed directly to the tax lien purchaser.
Unlike Wall Street, state laws set the rates that counties can charge delinquent taxpayers 16%, 18%, 24% up to 36% per year.
Property owners who pay back what they owe, pay the county, which then repays the investor what they paid to satisfy the delinquent taxes, plus whatever interest rate was set at the time of the sale.
With tax lien certificates, interest rates of 16%, 18%, 24% up to 36% are set by law.
A lot of people have seen their retirement accounts evaporate with the ups and downs of the stock market. With tax lien certificates, the interest rates are mandated by law:
12% per year in Alabama (Sec. 40-10-122),
16% per year in Arizona (Sec. 42-18053),
18% per year in Florida (Sec. 197.172),
24% per year in Iowa (Sec. 447.1),
36% per year in Illinois (Sec. 21-355).
The sale of tax lien certificates solves several problems. Communities get their much needed tax dollars, allowing them to fund daily services, property owners get more time to pay their delinquent taxes (usually 6 months to 4 years, this period of time is called the redemption period) and purchasers own tax lien certificates with law-mandated penalty interest rates of 16%, 18%, 24%, up to 36%.
The redemption period can be rather short in some states. For example, a property owner in Arkansas has only 30 days to redeem after the sale, and in Delaware the redemption period for owners is only 60 days. The District of Columbia, Maryland and Massachusetts permit the redemption period to be foreclosed as soon as six (6) months after the tax sale.
When the county collects the past due taxes (usually within 2 years) they mail the owner of the tax lien a check covering what was paid to satisfy the back taxes PLUS law-mandated penalty interest rates of 16%, 18%, 24%, up to 36%.
By law, real estate tax liens are senior to other liens including mortgages.
By law, real estate tax liens are almost always senior to other liens including mortgages, deeds of trust, judgment liens, and even IRS liens. Thus, because taxes are usually only a fraction of the value of the property, this makes the tax lien certificate a well-secured investment.
Since most property owners pay off their delinquent property taxes within a year and about 95% of the time back taxes are paid off within two (2) years.
If the property owner does not satisfy the delinquent taxes within the period of time specified by state law (known as the redemption period). Then, the county has the legal right to transfer the property to the owner of the tax lien.
Let me explain.
All across the country state governments have passed laws which make the real estate tax lien superior and senior to all other liens and encumbrances, in some instances this would include the mortgage.
Most states grant this "super-priority" status to property tax liens as a matter of statute while other states have reached the same result as a matter of judicial decision.
In the state of Florida:
"All taxes imposed pursuant to the State Constitution and laws of this state shall be a first lien, superior to all other liens, on any property against which the taxes have been assessed..."
- 2011 Florida Revised Statutes (Title 14 Ch. 197 Sec. 122)
Just like Florida, all across the country individual states have enacted similar laws which mandate that tax liens are "superior and senior to all other liens."
State laws authorizes county governments with the right to transfer the property to the owner of the tax lien.
What happens if the property owner does not redeem the tax lien and pay the county their delinquent property taxes?
If the county does not receive the property taxes plus interest and/or penalties within the period of time specified by state law, then according to state law the county has the legal right to transfer the property to the owner of the tax lien.
In return, the purchaser must pay any remaining property taxes and costs related with them (i.e. title and recording fee's) at which point the county execute a deed to the property.
Keep in mind, its estimated about 95% of the time back taxes are paid off within two (2) years and about 5% of the time they're not at which point state law grants the county the legal right to transfer the property to the owner of the tax lien.
Banks and Investors have been buying tax liens for years.
The idea of buying tax lien certificates with law mandated penalty interest rates of 16%, 18%, 24%, up to 36% is exciting especially given the current conditions of the global economy.
Double digit interest rates secured by real estate are just two of the many reasons why tax lien certificates have attracted the attention from some of the biggest banks and hedge funds in the country including Bank of America, JPMorgan Chase, and Fortress Investment Group.
The banks were dabbling in the tax lien business before the $787 Billion Stimulus Bill but they have ramped up their purchases since the crash of the housing market and bailout money became available.
We've covered a lot, let's review.
The sale of tax lien certificates helps local communities by paying a portion of these past due taxes so they can continue to fund important government services like police protection, public schooling, and emergency medical services.
The sale of tax lien certificates also helps delinquent property owners by giving them more time to pay off their taxes (usually 6 months to 4 years), and when the county collects the past due taxes they mail the owner of the tax lien certificate what they paid to satisfy the delinquent property taxes PLUS penalty interest rates of 16%, 18%, 24%, up to 36%.
The owner of a tax lien certificate has a first lien position on the property. This means the property owner cannot sell, refinance, get a second mortgage or home equity loan until the owner of the underlying tax lien certificate is paid the amount paid to satisfy the delinquent property taxes PLUS interest and/or penalties.
If the property owner does not satisfy the delinquent taxes within the period of time specified by state law (known as the redemption period) then, the county has the legal right to transfer the property to the owner of the tax lien certificate.
The owner of a tax lien certificate has a few options once they have received the property through the tax lien certificate; sell it, rent it, or even move in.
Tax lien certificates are exciting but require some due diligence.
I'm not a legal or financial advisor but in my personal opinion, tax lien certificates are the ideal investment. I would encourange anyone considering buying tax lien certificates to discuss it with a properly licensed legal, financial, or accounting advisor so they can know what measures need to be taken to avoid costly pitfalls. Here are a few but not all of the pitfalls of tax lien certificates and tax deed foreclosures:
Pitfall #1: Identify and Avoid Worthless Properties
Pitfall #2: Identify and Avoid Federal Tax Liens
Pitfall #3: Identify and Avoid Bad Neighborhoods
Pitfall #4: Identify and Avoid Bankruptcy
Pitfall #5: Identify and Avoid Costly Environmental Issues
Pitfall #6: Identify and Navigate Competitive Markets
Pitfall #7:  Identify and Navigate Uninsurable Titles
Tax lien certificates have the potential of providing a profitable investment, including double digit penalty interest rates which are mandated by law and secured by real estate. Alternatively, tax lien certificates can be a costly investment because there are some pitfalls which, if not avoided, could end up costing purchasers far more than what they initially invested.
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