If you aren't a real estate investor, you may not be familiar with equity stripping and how you, as a property owner, can benefit from it. In this article, you’ll learn all about equity stripping and how it can be used to protect real estate assets and avoid lawsuits, including:
- What equity stripping is;
- How equity stripping works;
- Types of equity stripping;
- Why someone would want to strip their property of equity; and
- The benefits that equity stripping can provide
Most borrowers use assets as collateral when it comes to obtaining a loan. Lenders take this into consideration because there would be no way to guarantee their lending risk. Sometimes cash flow is considered more important than collateral, but this is not always the case when it comes to real estate.
What is Equity Stripping and How does it Work?
Equity stripping is an asset protection strategy that involves encumbering real estate with liens to the extent that little or no equity is left in the property for claimants and creditors to take. The idea is to reduce the equity value in your property to little or nothing so that it is much less likely to attract litigation.
Equity Stripping is a strategy that is often used to reduce the value of property in order to protect that property or another property. Typically this strategy is used by those who are in debt, to appear as though they do not have equity in their investments. This can deter debt collectors and creditors from suing or pursuing the debt.
Creditors are less likely to try to pursue a claim against your property if it has little to no equity value. Because of this, equity stripping is considered one of the easiest asset protection strategies to implement—simply by rendering an asset less valuable, you can avoid lawsuits and minimize risk.
When implemented well, equity stripping is an excellent tool for both homeowners and real estate investors to protect their property from creditors and wanton litigation. Moreover, it is often the only way to do so.
Equity stripping began out of the need to protect property. By reducing the value of a property through equity stripping, it decreases any interest in a property because creditors believe the owner does not hold any equity.
At first this may seem like it is illegal, but in reality, it is not because the debtor is simply giving their equity to another party. The owner may be able to continue the use of the property, as well as any cash flow if it is being rented. The only difference is that legally the debtor will no longer own the property, meaning it will be an unattractive asset to possess.
While the name itself may sound a bit counterproductive, equity stripping is actually a long-standing and straightforward asset protection method used by property owners. There are various forms of equity stripping for different scenarios, but all forms are essentially aimed at the same goal of safeguarding your property ownership.
So, what exactly is equity stripping and how does it work?
Equity stripping is a financial strategy that’s implemented to reduce the overall value in a real estate asset. It’s considered a dependable asset protection strategy that makes properties appear less attractive to creditors and therefore reduce their likelihood of including the properties in a debt claim.
Typically, creditors and lending institutions won’t go through the trouble of levying a claim against a property if its equitable stake does not appear worthwhile. Meanwhile, the owner still retains control of the asset, including cash flows and use of the property. Additionally, when this strategy is paired with the limited liability protection of an LLC, you can protect both your real estate assets and your personal assets.
Keep in mind, however, that this strategy is not risk-free and only works if done correctly. It’s best to seek the advice of a legal professional before embarking on this course of action.
Types of Equity Stripping
There are many ways to strip real estate of its equity. However, the most common ways are:
There are a number of different strategies for stripping assets of their equity, but two methods in particular are the most common. These two types of equity stripping are known as spousal stripping and home equity lines of credit (HELOC).
- Spousal Stripping;
- A Home Equity Line of Credit; and
- Friendly Liens
Two of the most common types of equity stripping are:spousal stripping and home equity lines of credit.
Spousal Stripping
Spousal stripping involves transferring ownership of property to a spouse who, presumably, doesn't have as much debt. Transferring title to the property from a distressed spouse to a less-distressed spouse placing the property beyond the creditor's reach.
The transfer of title is typically achieved with a Quit Claim Deed. Quit Claim Deeds are very often used to transfer title to property when the person receiving the title is not paying anything for it. Once a Quit Claim Deed is executed, it releases the original titleholder of all interest and liability in the property.
A Quit Claim Deed is an easy and inexpensive way to strip equity from your property, but it comes with certain risks and will not work in every case. You should, therefore, speak with an experienced attorney before attempting this strategy on your own.
One common type of equity stripping has to do with giving the equity to the number one person in your life, your spouse. Spousal stripping means that the debtor will transfer ownership of the property that is in question, to their spouse. This should only be done if the spouse has less debt. This is done commonly because a spouse can be trusted.
Spousal stripping is an equity stripping strategy in which a debt-distressed owner transfers ownership of a property over to their spouse who has less debt. Transferring the property title like this will allow the debt-distressed owner to file a quitclaim deed in the spouse’s name.
A quitclaim deed is a method used for transferring interest in a property. In this case, the quitclaim deed will serve as a means of saying that the debt-distressed owner does not have a valid ownership stake in the property and thus protect it from creditors.
Home Equity Line of Credit
Homeowners can strip equity from their property by taking out a home equity line of credit (HELOC). A HELOC enables a homeowner to borrow against the equity in their home while using the home itself as collateral.
The HELOC will show up as a lien against the property, even if it is unfunded or you don’t use any of the credit. As a result, your home will look less attractive to creditors, who will then be more inclined to leave you alone or agree to favorable settlement terms.
More commonly referred to as a HELOC, a home equity line of credit is something that homeowners can take out against the equity of their home. It gives the owner the same amount of money that there is in equity, and they will use their home as collateral.
When borrowing against the equity in a home the equity is removed, essentially stripping it. The result of this is that creditors will see that the asset is no longer worth the time to collect on, and the owner will get more time to figure out their finances.
Another equity stripping strategy is a home equity line of credit, also known as a HELOC. This is when homeowners borrow against the equity in their home to diminish their equitable interest in the property. In this case, the home is used as collateral and becomes less appealing to creditors as the equity is stripped away, making it less likely that any claims are levied against the asset.
Keep in mind that while a HELOC will allow homeowners access to their home’s equity, it does not mean they must use it. In this way, a HELOC services as an equity shelter that does not add any additional debt to your situation.
Friendly Lien
By placing a "friendly" lien against a property, you remove equity from that property and make it unattractive to those trying to collect any type of legal judgment.
This can be achieved by using a holding company or other business entity that you own or control to place a first or second lien against a property via a mortgage, promissory note, or UCC filing.
In most cases, a lien against your property takes precedence over any subsequent liens. Therefore, once you place a friendly lien against your property, you render any subsequent creditor liens ineffective and worthless to the creditor.
Having any lien against your property is, ordinarily, a bad state of affairs that can ultimately result in you losing the property. But, when you place a lien against your own property, it can be a simple and effective way to protect it from unscrupulous creditors.
Why Would Someone Want to Strip Equity From Their Property?
When implemented well, and as part of an overall asset protection strategy, equity stripping is an excellent tool to protect real estate from being lost to creditors and potential litigation. What's more, when equity stripping is used in conjunction with an LLC, you can also protect your personal assets from any debts and liabilities arising out of ownership of the real estate.
For example, if you set up a separate LLC for each piece of real estate you own, and treat each as its own business, each property will be insulated from the liabilities of the others. So, if a lawsuit is filed against property X, properties Y and Z will be insulated from that lawsuit. Similarly, if you treat each LLC as an entity separate from yourself, any lawsuits filed against the property it holds will only affect the LLC itself, not your personal property and assets.
Whether you’re a homeowner or a real estate investor, there are several ways that property owners can utilize equity stripping to protect their real estate assets. Essentially, any individuals that want to make themselves and their assets appear less attractive to creditors would likely find equity stripping a viable strategy.
Consider the following example to get a sense of how equity stripping can be used to protect your property assets. Say that you’re a homeowner who has built up $200,000 worth of equitable stake in a $400,000 home. In other words, you’re half way to fulfilling your mortgage obligations on the home (not including interest). Using a home equity line of credit (HELOC), you can borrow against your equitable stake in the home, using it like a $200,000 line of credit. As you do this, you’re simultaneously diminishing the value of the asset and therefore making it less attractive to any potential creditors.
Additionally, equity stripping is a legal asset protection strategy when carried out correctly. Generally, it’s permissible so long as you make the necessary moves prior to any lawsuit or creditor having claim. Utilizing an LLC is another way to strip equity and protect your assets from creditors, as you can only be found liable for your interest in the LLC.
Keep in mind, however, that equity-stripping strategies are not bulletproof. There may be certain exceptions that surpass the liens placed against your assets, such as a federal tax lien in which the government has an interest in your property. For this reason, always consult a legal professional when carrying out such a strategy.
The Benefits of Equity Stripping
Equity stripping is not for everyone, but there are some advantages of equity stripping. Here are5 key benefits of equity stripping.
- Creditors are less likely to pursue a claim against your property if there is not enough equity in it to satisfy their claim.
- A HELOC will give you access to credit, but you don't have to use it. In this way, the HELOC protects your equity in the property, but does not burden you with extra debt.
- Equity Stripping can be used in conjunction with a business entity such as an LLC for more asset protection and to make your property even less attractive to creditors.
- Creditors will be turned off: Oftentimes creditors will avoid pursuing property in debt if there is not enough equity in it which is the main purpose of equity stripping.
- Provides more money to invest: It can allow you to take out a loan on your own property, which then provides cash to put into a new investment. This might include a new mortgage, second mortgage, or HELOC. These are often easily granted by banks.
- Use traditional LLCs: This can be done to strip equity and make assets less appealing to creditors.
- Continue use of assets: When investors practice equity stripping it is a bit different than that of those who are in debt. If an investor wants to strip their equity, they can continue collecting rent even while switching the legal ownership of that asset.
- Re-invest equity: Investors that engage in equity stripping not only make their assets look attractive should they fall into debt, but also provide them the opportunity to reinvest the equity they have built up.
Consult With an Experienced Wyoming Legal Professional
As an asset protection tool, equity stripping can be a simple but effective means for real estate investors and homeowners to render their property less attractive to creditors and litigants. That said, there are certain exceptions and risks associated with equity stripping that often require special consideration.
Therefore, before attempting to implement this asset protection strategy on your own, you should consult with an experienced Wyoming legal professional who can help you minimize any risks and avoid any complications.
Why Would Someone Want to Strip Their Equity?
Equity stripping is a good option for real estate investors, as well as everyday debt borrowers. Since laws do not always protect the equity in each home or property in the same manner.
In some cases, even if you have paid off your home more than someone else, it will not be protected anymore. This is why one might want to practice equity stripping, as it is a legal method for protecting your home.
Legalities of Equity Stripping
Equity stripping is a practice of removing value from your assets in order to make them look less desirable to creditors or to provide investors with money to reinvest. In many cases this will make you appear to hold fewer assets, therefore creditors will not want to sue you. This is completely legal, but it needs to be done before a creditor goes after your assets.
