What is a Tax Lien?

For many financial instruments, it is often better to answer the questing of why it exists instead of what it is. The what, after all, is just paperwork and record keeping. Below is my understanding of why tax liens exist. Most of my understanding comes form the Moskowitz book, wikipedia, and some other random Internet sites.

Counties and other municipalities create a budget for their spending for the next year. The size of the budget depends on how much money they expect to bring in through various taxes and fees. Which projects can be started, completed, and most importantly paid for depends almost entirely on how much they expect to raise. Property taxes are the most common ways counties bring money into their coffers, and the biggest consideration when determining a spending budget is how much money they will collect.

Municipalities usually rely on state laws to enforce the collection of taxes and provide for penalties to encourage tax payers to not be delinquent with their payments. These penalties include charging a fairly high interest rate on late payments, and they usually provide for the seizure of property if the taxes are not paid within a certain time frame. While these laws ensure most people will pay their taxes on time, not everyone can or is willing to do so. The municipalities can and do collect the late fees and eventually foreclose on the properties, but that does not solve their main problem. That problem is they have spent or promised payments in one calendar year, and they cannot wait the three or more years it could take to get the money through a foreclosure. Also, the municipalities are not in the real estate business. While the law in on their side, they do not necessarily want to invest in the resources to manage the whole process from start to finish. One possible solution to the issue is to get investors involved.
 

By selling tax liens to investors, the counties win by getting the money they need to pay their bills. This means the citizens of the county win as well. The investors win because they want the returns they get by investing their money. The property owners whose properties the liens are written against are no worse off they they were to begin with (well, unless they were counting on the inefficiencies of the municipalities to snag a couple of months delays in foreclosures), and they might actually catch a bit of a break if the municipalities pass on a lower interest rate that was bid down by investors. It is rare to have a situation where there are wins all the way around, but tax liens seem to fit that bill.

Tax liens are sold at auctions. The auction rules and dates are often dictated by state laws. The lowest bids from investors wins the lien with one random winner chosen in the event of tie bids. Any liens not sold at the auction can be purchased directly from the municipality at the highest interest rate allowed by law. In my very limited experience, I would warn you NOT to count on getting anything other than raw land at or near the full interest rate. I am guessing that Internet Auctions are what is really driving the winning bids down.

So, what do you do after you win and pay for your liens? No much. The municipalities eventually collect the money for the redeemed liens for you (principal and interest). If you have held the liens for the prerequisite length of time (as defined in the state's laws), you can request a foreclosure to redeem your money. This will take some action on your part, but if you choose your tax liens carefully, depending on the laws of the state the property is in, this is were you can really make some money.