Intermission: What are tax liens?

The feedback I’ve gotten so far has been: “uh, what are tax liens?”  Here, I backtrack to explain what tax liens are.

Most counties have property taxes.  So, what happens when a property owner fails to pay these taxes?  The county still has an obligation to spend money according to its budget, and now the county has a shortfall.  Where will the county come up with its money?  In Colorado, liens are the answer.

Investopedia’s definition of lien is “the legal right of a creditor to sell the collateral property of a debtor who fails to meet the obligations of a loan contract.”  So, it is simply the loaner’s view of “loan with collateral.”  Liens are everywhere — most homeowners have a lien on their house in the form of a mortgage, and many automobile owners have a lien on their car in the form of a car loan.  The person or entity who is loaning this money is called the lienholder.

So, in Colorado, the county attaches a property tax lien, or simply tax lien, to the property in the amount of the taxes owned plus interest.  Failure to pay on the tax lien means the property passes to the lienholder.  The lien is then sold by the county in a tax lien auction.  These liens usually have a high interest rate attached to them; in Colorado, the interest rate is 10% and considered “low” compared to other states.

For a property tax lien to go away, or be redeemedthe property owner must pay down the taxes owed plus any accumulated interest.  If no payment is made and the property goes to a lienholder, this is called a transfer of deed. 

Auctions can be in-person or online.  Methods of auction vary from state to state and even county to county.  Most counties in Colorado go on a premium basis, which means you bid an amount at or above the face value of the lien which is the amount of tax owed by the property tax holder.  For instance, if the lien face value is $100, you can bid $102 which means you’ve paid a 2% premium.

What’s the catch?  Part II covers the risks.  Basically: 1. the lien is redeemed too soon to make a profit, or 2. the lien is on an unprofitable property and never gets redeemed.

There are more details here I haven’t covered, for example: whether municipal liens (think sewer, electric bills) or mortgages pass onto the lienholder in a transfer of deed, whether IRS liens can trump these property tax liens, and various state-specific quirks.  I recommend checking out a good book on tax liens from the local library for further interest, but overall, they are next-to-treasuries in investment safety.

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