Knowledgeable real estate paper investors can earn far higher yields than most people. Those yields aren’t federally insured, but they can be very well secured, in an investment few people know about: local government tax lien certificates.
What a tax lien certificate is
Tax lien certificates are a form of real estate paper. An investor pays the county treasurer the delinquent real property taxes due on a particular parcel. In return, the treasurer issues a document called a tax certificate, often more formally called a Certificate of Purchase.
The certificate is secured by an assignment to the investor of the county’s real property tax lien. The property owner must then repay (or “redeem”) the taxes the investor paid, plus a yield set by law, or lose the property.
Tax lien certificates are available in most, but not all, states. The yields differ from state to state, and in Maryland they differ from county to county.
How the Iowa yield works
At the time of writing, Iowa offered one of the most impressive yields available: 24% a year, simple interest.
In fact the yield was even better than it sounds. Technically it was “two percent per month, counting each fraction of a month as an entire month, from the month of sale.” If you bought a certificate and it was paid off the next day, you would receive 2% on your money. Compare that with the 3% or so a year a bank money market account paid at the time.
Why the lien is so well secured
Bank money market accounts and 90-day Treasury bills pay much less, but they are federally insured. A tax certificate is secured instead by the real property tax lien against the particular property whose delinquent taxes you paid.
That lien is a special “priority” lien. Its priority doesn’t depend on the date and time it was recorded, but on a special statutory provision.
Under Iowa law, the tax lien is senior to all mortgages, mechanics’ liens, judgment liens, and state and federal tax liens, no matter when they were made or recorded. By operation of law, it is the first lien against the property.
Foreclosing the right of redemption
Under the Iowa rules described here, if a certificate isn’t redeemed within one year and nine months of the sale, the certificate holder can “foreclose out” the right of redemption. To do it, the holder serves the owner and any lien holders with a 90-day Notice of Expiration of Right of Redemption. If the certificate still isn’t redeemed by the end of the 90 days, the investor takes title to the property:
“Immediately after the expiration of ninety days from the date of completed service…the county treasurer shall make out a deed for each parcel sold and unredeemed, and deliver it to the purchaser upon the return of the certificate of purchase.”
The certificate holder takes title free and clear of all liens for, in effect, about three years of back taxes, penalties, interest and “foreclosure” costs.
Tax liens compared with bank lending
At the time of writing, a bank or thrift borrowed your money at 3%, 4%, 5% or 6%. It then lent that money to home buyers at 8% to 8.7% on 30-year fixed-rate loans, secured by first mortgages or deeds of trust with loan-to-value ratios of 80% to 95% when made. If the borrower defaulted, the thrift would probably end up with a repossessed (REO) property, which it would probably sell at a loss.
Had you put that same money into Iowa tax lien certificates, you could have earned 24%, about three times what the banks and thrifts were earning. Your yield would have been secured by a first lien (not just a first mortgage or deed of trust) with a loan-to-value ratio of 3% or less when made. And if the owner defaulted, you would have gotten the property for a small fraction of its value.
Do your homework first
If you have cash to invest, tax lien certificates are worth investigating. But tax liens can be tricky. Each state, and sometimes each county, has its own rates, redemption periods and procedures, and the rules change. Learn the current rules where you plan to buy before you put money in.
