The premium is an amount above the amount of the tax lien certificate that the investor will pay to the municipality to acquire the lien. When the premium is paid for a lien, it is not the lowest interest rate offered that earns the lien, but the higher premium. The premium is not offered in all states that sell links. In some states, the interest rate is offered at a lower rate and the lien is sold to the investor offering the lowest interest rate. In other states, the interest rate is held constant while a premium is offered for the lien, which reduces your yield on the lien (since most states do not pay interest on the premium).
Each state has its own rules regarding offers and whether or not a premium is offered. New Jersey is unusual in that the interest rate is bid lower and once the interest is bid 0%, the premium is bid. This means that the investor does not earn interest on the amount of the certificate or the premium, which significantly reduces the returns on this investment. The only interest charged in this case is the interest paid on subsequent taxes, which in New Jersey is 18% for bond amounts over $1,500.00.
In New Jersey, the municipality retains the premiums and if the lien is not redeemed within a 5-year period, that money is not returned to the investor. Of course, the investor can start foreclosure proceedings after 2 years, but if the property is foreclosed, the investor does not get the premium back from him. He can get the property, but the premium will be forfeited and considered part of the cost of the property. The rules about when and if the premium is returned to the investor and whether or not interest is paid on the premium offer are different for each state.
Why did this happened?
At almost every tax lien sale I attend, there is a local investor, new to tax lien investing, who is confused and wants to know what is going on. Why would someone want to buy a lien, pay more than the lien amount, and get no interest on their initial investment? They assume that investors do this in the hope that they will be able to foreclose on the property.
The real reason tax lien investors pay a premium is that once you own the lien, then you have the ability to pay subsequent taxes. In New Jersey, you can earn 8-18% on subsequent taxes, depending on how much is owed. For amounts owed greater than $1500.00, the interest rate is 18%, for amounts owed below $1500.00, the interest rate is 8%. Also, whenever the lien is redeemed after the certificate is issued, even though you have not obtained the certificate amount at an interest rate, there is an additional redemption penalty paid to the lien holder. The New Jersey redemption penalty is 2% for certificate amounts from $200.00 to $4,999.99, 4% for certificate amounts from $5,000.00 to 9,999.99, and 6% for certificate amounts from $10,000.00 or more. The homeowner must pay this penalty when the lien is redeemed and it is only calculated on the amount of the certificate, not on any subsequent taxes paid by the lien holder. Each state also has different penalties that can be applied in addition to the amount of interest on the bond.
On top of all this, some New Jersey municipalities have an additional year-end penalty for back taxes that exceed $10,000. A 6% penalty is added for amounts owed over $10,000.00 at the end of the year. This penalty only applies to subsequent taxes. So, if you are the holder of a lien and you paid more than 10,000.00 in subsequent taxes, at the end of the year the owner will have to return 24% to you, in case you redeem the lien, plus you will receive the redemption penalty in the amount of the lien. certificate of your link.
A simplified example
Let’s look at a somewhat simplified example: Let’s say you go into a sale and a $5,000 lien on a property with annual taxes of $10,000.00 (not unusual in some New Jersey municipalities) and offer a $10,000 premium. You pay the municipality $15,000.00 (amount of lien + premium) on the day of the sale. The sale happens to take place on December 1 and last year’s delinquent taxes are being sold. On December 11, you pay taxes for the current year of $10,000.00. And let’s assume the lien is redeemed on December 11 of the following year and you paid no further taxes thereafter.
To redeem the lien, the property owner must pay the amount of the certificate plus the redemption penalty and the amount of the subsequent 24% tax. That’s $5,000 (lien amount) + $200 (4% redemption penalty) + $10,000.00 (later taxes) + $2400.00 (24% subs) = $17,600. The municipality has to return your premium of $10,000.00. You collect $27,600.00. His initial investment was 25,000.00. You have a total profit of $2,600.00 for a return of 10.4%. This is a simplified example. Your actual yield will be slightly higher if you continue to pay subsequent taxes until the bond is redeemed.
