How Does a Tax Lien Foreclosure Work?

The word foreclosure probably makes you think of a bank selling a home or other real property because the borrower fell behind on mortgage payments. That is the most common type of foreclosure, but it’s not the only one. Each year, there are billions of dollars in tax lien foreclosures around the country. 

Depending on where the property is located, past-due property taxes may lead to a tax lien foreclosure or a tax deed sale. The tax lien foreclosure process includes some additional protection for property owners. But, the bottom line is the same. If your property taxes are delinquent, you could lose your property to a tax lien foreclosure or tax deed sale—even if your mortgage has been paid in full.

What Is a Tax Lien Foreclosure?

A property tax lien is a lien placed on real estate when the property taxes haven’t been paid. Unlike other types of tax liens, the property tax lien is usually only attached to the property that has unpaid taxes. In one sense, that’s good news. It generally means other property is safe from collection relating to the tax lien. But, the risk to the home or other real property is serious. 

There are billions of dollars in unpaid property taxes across the country. And, many local governments can’t afford the revenue losses they suffer when property taxes go unpaid. Taxpayers suffer because of unpaid taxes, either in higher tax rates or in reduction of services. Tax lien foreclosures and tax deed sales allow the governmental entity to promptly collect those unpaid taxes from a third party.

In a traditional foreclosure, the property itself is sold to pay off the outstanding debt. In states that use tax lien foreclosure, the process is different. Instead of auctioning off the property, the local government auctions off the tax lien. In some states, this happens the old-fashioned way: a public auction on the courthouse steps. But, increasingly, auctioning of tax liens and tax deeds is moving online. In some counties, there is no foreclosure auction. Instead, these interests are sold in bulk to investors.

If the auction bids are too low, the lien may not be sold. If the minimum bid is reached, the winning bidder gets a tax lien certificate. The certificate gives the buyer the right to collect the back taxes with interest and certain costs and fees. The interest rate is often quite high.

Clearing the Lien

In most states, the property owner has a right of redemption. That means there is a period of time that the homeowner can clear the tax lien. Clearing the tax lien means paying the back taxes plus any interest, fees, and costs due. Depending on state law, this period may be as short as a few months or as long as a few years. 

Clearing the lien can be a challenge for homeowners. If they weren’t able to pay the original balance, it only gets harder as the balance grows. The interest charged by the investor, along with other fees and costs, can significantly increase a tax bill. A debt of a few hundred dollars could be in the thousands by the time the redemption period expires. 

In some situations, the homeowner may be able to clear the lien by selling the property. Understandably, this won’t be most homeowners’ first choice. But it may allow them to preserve equity that would otherwise be lost in a property tax sale. 

When the Lien Isn’t Cleared

If the property owner can’t clear the lien within the redemption period, the process moves forward. In some states, the deed to the property is automatically transferred to the lien purchaser when the redemption period expires. In others, the lien purchaser must apply for a deed. This process also differs from state to state. It may be as simple as making a request to the local taxing authority. In other cases, judicial foreclosure proceedings may be required.

What Is a Tax Deed Sale? 

A tax deed sale is similar to a tax lien foreclosure, but it’s more direct. This process usually offers less protection for the property owner. In a tax lien foreclosure, the lien is sold. Then, there are additional steps before the title to the property transfers. In most cases, the property owner pays off the lien and the deed is never transferred. 

In a tax deed sale, the municipality goes straight to auctioning the property. Most tax deed sale states don’t build in redemption rights for the property owner. Because of this, the process can move quickly.

The minimum bid in a tax deed sale is typically the taxes owed, plus interest and the costs of the sale. In other words, a house or other piece of real estate worth hundreds of thousands of dollars could be auctioned for a tiny fraction of its value. That’s bad news for the homeowner, and potentially for other lienholders, such as a mortgage lender.

Tax Liens Take Priority Over Other Liens

Tax lien sales present a special risk for homeowners, mortgage lenders, and other lienholders.  That’s because the property tax lien takes priority over any other lien. That means the property taxes are paid first. But, it also means that any other lienholders might not get paid at all. And, there is rarely anything left for the homeowner.

Imagine, for example, that a home is valued at $150,000. The homeowner has $100,000 in equity in the home. The original mortgage lender has a lien for the remaining balance on the mortgage loan: $50,000. 

The mortgage loan takes priority over most other interests. For instance, if the homeowner sells the property, the mortgage lender gets paid first. The same is true if someone sues the homeowner and gets a lien on the property. That means the mortgage lender would get the first $50,000 if the home was sold. Any other lienholders would then be paid. Finally, if there was anything left over, the balance would go to the homeowner.

In theory, a tax deed sale works the same way in many states. The only difference is that the tax lien holder gets first priority,  even before the mortgage lender. For example, say there’s a $5,000 tax lien on the property described above. The property is sold at a tax deed auction for $100,000. 

The tax lienholder would get $5,000 plus costs. The mortgage lien holder would get the full payoff balance of $50,000. The homeowner would receive the balance. In this case, the homeowner’s share would be approximately $40,000. That’s far less than their equity in the home, but much more than most homeowners actually receive after a property tax sale.

The problem is that tax lien sales rarely yield significant sums. In fact, in some states, the property is always sold for the amount of the tax lien plus costs of sale. So, in the example above, the property would be sold for $5,000 plus costs. The mortgage holder would get nothing. The homeowner would get nothing. And the investor would walk away with a $150,000 home for $5,000 plus costs. 

Even in processes that involve competitive bidding, the bids are typically quite low compared to the value of the property.

Laws and Processes Vary From State to State

While there are some common threads, the actual procedure for a tax lien transfer varies significantly from state to state. For instance, in New Hampshire, there is no sale at all. A tax lien gets “super priority,” and if the homeowner doesn’t pay the property taxes in the time allowed, ownership of the property is simply transferred to the municipality. 

Here are examples of how each of the most common types of sales work. Keep in mind that the specifics will vary from state to state, even within each category.

Tax Lien Sales

Colorado is a tax lien sale state. It holds a tax lien auction once each year. The buyer pays the tax, all accrued interest, an advertising fee, a certificate fee, an auction fee, and any premium amount the buyer bids. The highest bidder receives a tax lien certificate that includes the taxes, plus the other fees. The interest rate is determined by state law. It is not part of the bidding equation.

There is a three-year redemption period in Colorado. This means the property owner has three years to pay past-due amounts, interest, and other fees. If property taxes are delinquent in subsequent years, the lienholder can pay them and have the amount added to the lien certificate. If the property owner hasn’t paid up by the time the redemption period expires, the lienholder can apply for a Treasurer’s Deed and claim the property.

Tax Deed Sales

Georgia is a tax deed sale state. In Georgia, the homeowner gets a 30-day notice of delinquent property taxes. If the taxes aren’t paid within that 30-day period, the sheriff’s department can be ordered to seize and sell the property to cover the outstanding balance. This order triggers another 20-day notice period,  an obligation to advertise the sale for four consecutive weeks, and an additional written notice to the owner. Then, the property may be sold at auction. If no bids are sufficient to cover the outstanding tax debt, including accrued interest and costs, the county may purchase the property itself.

Whether the property is sold to the county or to a private bidder, the property owner has 12 months to redeem the property. Property is redeemed by paying the amount paid at the tax sale plus taxes paid on the property post-sale, any special assessments on the property, and a premium. The premium is 20% of the amount for the first year, plus 10% for each additional year. Under Georgia law, the property may be redeemed by the property owner or by another interested party, like the mortgage holder. Alternatively, the property owner and any lienholders may claim excess proceeds of the sale.

It’s important to note that these are just examples. Key steps and protections differ from state to state. For instance, notice requirements and redemption periods vary. Some tax deed states don’t even offer a redemption period. It’s important to educate yourself about the specific timelines and procedures in the state where your property is located. 

Let’s Summarize…

Delinquent property taxes can cost you your home. If you’re behind on property taxes, contact your county as soon as possible to find out whether they offer assistance or if you can delay your property taxes or enter into a payment plan. 

Even when there is a redemption period available, interest and other fees can rapidly increase the outstanding balance. This can make it difficult to redeem the property. So, it’s important to act quickly when you receive a notice of delinquent property taxes.