Bid Down the Interest Rate
Most writers will tell you this system is used in more places than any other, but I’m not sure that is correct. It is used in Florida, Arizona, New Jersey, Illinois and maybe a couple of other states. The thing that is important about the system is that Florida, Arizona, New Jersey and Illinois are all big lien states. In total liens sold they are probably about 40% of the total lien market.
The way this system works is that bidding starts at a statutory rate (18% in NJ, IL, and FL, 16% in AZ), and the interested buyers bid a progressively lower interest rate until nobody is willing to go lower. The lowest bidder is the winner. As an example, lets assume the starting rate is 16%. The second bid might be 15%, then 14%, and so on until the bidding stops at 7%. To give you an indication of how this works – the Arizona rate is 16% but the average purchase yield in the 2002 auction was 10.95%.
When you read the description of the bidding it sounds very orderly and easily done – now for a touch of reality.
In the Cook County, Illinois sale (Chicago) which goes on for over 30 days, they don’t start at 18% and bid down. The auctioneer reads out the parcel number, the amount owed, and every person in the room screams their lowest bid and the auctioneer “hears” the lowest bid.
This system extremely subject to manipulation but it isn’t really a sham since the auctioneer has no idea who bid the lowest rate first.
After 30 days of this you are ready for the “Happy Dale Home for the Mentally Bewildered”. I don’t want to just pick on Chicago though. There are a number of “bid down” jurisdictions where the opening bid yelled out will be well below the state bid.
This is just a method of speeding up the auction and letting everybody go home a little sooner. One thing you should understand – the best properties seldom, if ever, will go for the statutory rate. They will almost always be bid down substantially.
Another thing to remember about “bid down” states: There are a number of reasons why the rate may be held down to levels you find silly. If you see this being done extensively – there is a reason. A couple of examples: In Florida you may see properties that are sold for ¼ of 1%. Seems pretty low, doesn’t it? But in Florida there is a 5% penalty minimum and the lien buyer gets the rate he/she bids or the 5% penalty, whichever is more. If the lien buyer is fairly sure that the property will pay off in the three months (I have no idea how they would know this, then a bid of ¼ of 1% makes sense because the lien buyer will make a 20% annualized return if the lien redeems in 3 months. Where did 20% come from – well, lets take a look:
Assume the lien is $1,000.00. Three months of ¼ of 1% equals $1000 x .0025/12 months x 3 months equals = $0.625 – a wonderful 62.5 cents. What is the 5% penalty add up to? That would be $1,000 x .05 = $50.00. That is quite a bit better, but where did 20% come from? The annualized return for the penalty would be $50.00/90 days x 365 days = $202.78 a year. $202.78 a year on an investment of $1,000 is a annualized return of 20.27%. That is why you will see a bid of ¼ of 1%.
In both Illinois and New Jersey you will see bidding that you do not understand and rates that seem too low to be justified. They may prove to be too low, but the bidders have rational assumption they are basing the bid on. This, in the case of New Jersey, will relate to posting subsequent taxes and in Illinois it has to do with the rate increasing each six months.
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