What is a Tax Lien?

May 25

At its simplest, a lien is "the legal claim of one person upon the property of another person to secure the payment of a debt or the satisfaction of an obligation."

There are many different kinds of liens, not just tax liens. Residential mortgages are a form of lien; a bank has a legal claim upon a property and dwelling as security against the owner failing to make regular payments. There can be more than one lien against a property, e.g., a mortgage and a property tax lien.

A tax lien is placed against a property when the owner fails to pay property taxes, or, in some cases, income taxes or even municipal fines. Because property taxes pay for the majority of municipal services (including schools and police and fire departments), municipalities who hold tax liens offer them to investors as a way to offset the loss of tax revenues. Investors agree to pay the property taxes in return for a guaranteed rate of return as well as having the opportunity to take ownership of a potentially valuable piece of property—through foreclosure—at below-market rates.

When there is more than one lien against a property, the order (or priority, or seniority) in which lienholders are paid depends on the date the lien was "perfected" or filed. Older liens - the ones that have been active the longest - are given priority over newer ones. However, in most jurisdictions, this is not the case with tax liens, as taxes are mandated by governments. Thus, the holder of a tax lien against a property jumps to the head of the queue when it comes time to repayment and other rights.

New Jersey's tax lien laws are very favorable to investors. The law allows returns up to eighteen percent (18%) annual interest rate to be paid on a tax lien certificate and subsequent tax payments. In New Jersey, the property tax lien is also a "first position lien," preceding even Federal tax liens and property mortgages.

Tax liens are secured by the value of the underlying property and earn interest which is guaranteed by the agency selling the tax lien. The maximum interest rate is usually set by the state government, and the "price" of the tax lien is often determined, in part, by the rate of interest the buyer is willing to accept.

Tax liens are considered to be "fixed income" investments. The interest rate is fixed at the time of sale and payments are made on a regular basis. Only a very small tax liens end up in foreclosure and their value at that point is the difference between the assessed value of the property (for tax purposes) and the market value of the property.

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