Real estate investing is still one of the best and most popular ways for generating income and diversifying your investment portfolio. If you are looking for another type of investment that fits well with real estate, property tax lien investing may fit the bill. Below, you can learn more about the basics and whether it may (or may not) be right for you. 

What Is a Property Tax Lien?

When a land, property, or homeowner does not pay taxes on his or her property, the local area – usually the city or the county – has the right to place a tax lien on that property. Essentially, the lien makes it impossible for the property owner to sell or refinance until any back taxes have been paid. It is a 100% legal claim against a property made to recoup the unpaid taxes. 

Understanding Tax Lien Certificates

At the time that a tax lien is issued against a property, the municipality (city or county) issuing it will create what is known as a tax lien certificate. It is a legal document showing the exact amount owed on the lien, including not only the back property taxes, but also any fees, penalties, and interest associated with the unpaid taxes. Then, the municipality will auction that certificate off to the highest bidder in hopes of recouping as much of their money as possible as quickly as possible. For small plots of land or run-down homes, you may be able to purchase the certificate for a few hundred dollars. Most, however, sell for far more. 

What Happens When You Buy a Tax Lien Certificate?

When you buy the tax lien certificate, you become the legal lienholder. This means that you can either collect the payments owed on the property – the amount reflected on the certificate you purchased – or foreclose on the property as long as you do so according to the law. While this might seem like a win-win situation and a quick way to get your hands on some cheap property, tax lien investing is quite risky, so it isn’t for everyone. 

Things to Keep in Mind

Before buying a tax lien certificate, the National Tax Lien Association, or NTLA, has a few guidelines you should keep in mind. 

  • Do the math. Divide the amount of the tax lien certificate by the market value of the property. If the number is anything over 4%, it’s best to avoid buying that certificate. 
  • Look for other liens. It is the certificate buyer’s responsibility to determine if any other liens exist on the property that may prevent them from taking further action should the certificate go unpaid. 
  • Understand the repayment schedule. In most of the 30 states that sell tax lien certificates at auction, you’ll be required to allow anywhere from six months to three years for the property owner to repay the certificate in full. 
  • Check the expiration date. When you purchase a tax lien certificate, be sure that you understand the expiration date. After that date, you cannot collect any unpaid balance. 
  • Banks and hedge funds buy tax liens, too. It is not uncommon to find yourself bidding against banks and hedge funds for tax lien certificates. This drives up prices substantially and, in some cases, may drastically reduce profitability. 

If you are interested in finding new ways to diversify your investments, tax lien investing may be a good opportunity for you. Just keep in mind that it does require work and research on your part, and in most cases, there’s a great deal more risk with liens than with traditional real estate.