When a financially strapped homeowner defaults on his or her mortgage payment, there is a good chance he or she will also default on property taxes. When this happens, a property tax lien will be issued for the dwelling. Once a lien is issued, the homeowner cannot sell or refinance the home until he or she pays the overdue taxes. Typically, to speed up the repayment process, the county or town that is owed the unpaid taxes will create a tax lien certificate which includes the amount of overdue taxes plus interest and penalties. It will then auction off the certificate. These tax lien certificates pose an enticing investment opportunity for many savvy individuals.
What the Tax Lien Certificates Entail
Towns and counties sell tax lien certificates as a way of collecting overdue taxes in a quick, no-nonsense manner. When investors buy the liens at auction, they pay the full amount of taxes owed. In exchange, they get the right to collect that money back plus money in interest and fines. Alabama, as do all other states, places a maximum limit on how much in interest a person can collect. In Alabama, the maximum allowable interest is 12 percent. Generally, the winner of the lien certificate is the bidder willing to accept the least amount of interest in return for his or her efforts.
How Investors Make Money Off Buying Tax Liens
One might expect that the business of buying up tax lien certificates would have no real monetary appeal. However, savvy investors are often able to make a living off buying up certificates alone. For one, the promise of interest and penalties exists. If the delinquent property owner repays the overdue taxes within the time allowed by state law, the holder of the lien certificate gets his or her money back in addition to interest and fees. But what if the property owner does not make good on the debt?
In the event that the property owner fails to pay off the lien, the certificate holder can foreclose on the property and take ownership of it. From there, the winning bidder can do with the property what he or she desires. It is rare that tax liens come to this, however.
Risks of Buying Up Tax Liens
Purchasing tax liens may sound like a source of passive income, and while it is undoubtedly more passive than many other types of work, you still need to put forth some effort. Otherwise, you risk losing out on a large sum of money.
One risk of which to be wary is poor property conditions and low land value. Though rare, it has happened that a structure on a parcel of land gets destroyed in a fire, flood, or other natural disaster. In these cases, the certificate holder often ends up having more invested in the lien than what the plot of land is worth. You can avoid this risk by scoping out the property before auction day and making sure the property has enough value to cover the cost of past-due taxes.
Another risk of buying up tax liens is that the tax lien may be invalid. Sometimes, the county or city fails to follow through with proper lien procedures, which could render the lien void. For instance, maybe the county clerk never issued the notice, or maybe the city treasurer never applied a partial payment. If the city made any procedural errors regarding the property, past-due taxes, or the lien, the consequences of those mistakes may fall on you.
A third and final risk of investing in tax liens crops up when the property owner fails to pay his or her taxes for yet another year during the redemption period. If this happens, the municipality can lien the property again. If another person buys that lien, you lose your rights to your investment. You can prevent this from happening by monitoring your investment and paying the newly overdue taxes if necessary.
Consult With a Alabama Real Estate Attorney
Purchasing tax lien certificates can be a smart investment decision. However, like with any good investment, you need to do your due diligence and remain proactive to ensure you receive the ROI you set out to attain. For advice on how to reduce your risk and protect your investment, contact the Alabama real estate lawyers at Cloud Willis & Ellis today.