Tax Lien Investing: Interest Rate Or Penalty, What's The Difference?
If you've been looking into investing in tax liens or redeemable tax deeds
, you may have noticed that each state has a different interest rate that the investor is entitled to, and in some states the maximum interest is bid down at the tax sale. But what you may not know is that sometimes what you are getting is an interest rate and sometimes it's a penalty, and weather you get interest or a penalty (or both) can make a big difference on your rate of return.
Some states give either a penalty or an interest rate, but some states will give you a penalty on top of the interest rate that you bid. In New Jersey for example you get the interest rate that you bid on the certificate amount plus the penalty and you get the maximum interest (but no penalty) on any subsequent taxes that you pay. In other states, like Florida, for example, you get the interest rate or the penalty but not both. In Florida the interest rate is typically bid as low at .25%. Some people wonder why investors would be so low, but they do that because they know that they'll get the mandatory 5% penalty instead of the .25% interest that they bid. That is because most counties in Florida will apply the penalty for anything that does not profit at least 5%.
The real difference between a penalty and an interest rate is that a penalty is paid over time, usually it's annualized or for some states (like Illinois and NY) it's calculated over a 6 month period. In New Jersey and Florida for example, the maximum interest rate is 18% but that's 18% per year, not a straight 18% on your investment. In Illinois the interest rate is also 18%, but that is for 6 months, so if the lien is held for a year, you actually get 32% interest. But if it redeems in only one month's time you only receive 3% (3% per month over 6 months=18%) on your investment.
Contrast that with purchasing a redeemable deed in Texas. In Texas you receive a penalty, not interest on your money if the deed redeems. The penalty is 25% and the redemption period is 6 months for non-homesteaded and non-agricultural properties. So if you purchase a redeemable tax deed and it redeems after 6 months you make 25% on your money. But you also make 25% on your money if it redeems in only 1 month. That's the benefit of getting a penalty instead of an interest rate.
The bottom line is know the state laws in the state that you're investing in before you bid so you know if you are getting an interest rate, a penalty, or both. This will also help you determine which are the best states to invest in. But before you decide where you are going to invest find out what the liens are typically sold for not just what the law allows. You want to know how much interest is typically bid if the interest rate is bid down, or how much premium is paid if the amount of the lien is bid up. For states where you do bid premium, it's important to know if interest is paid on the premium bid (in many states it's not) and if you get your premium back if the lien redeems or not.
by: Joanne Musa
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