As a mortgage gets paid down, the home becomes a store of value for its owner. To other parties, that store of value can be “deep pockets” that make suing more attractive.
With equity stripping, a homeowner reburdens the property with debt. Now, other creditors can’t find much unclaimed value. By collaterizing the home, an owner hopes to shield it from being targeted in lawsuits.
Stripping a home of its equity, then, means using the home as collateral for a new loan. Often, it means taking out a home equity loan, or applying for a home equity line of credit (HELOC).
Lowering Some Risks…But Adding New Ones?
Some people are involved in businesses that make them the targets of lawsuits for financial reasons. Maybe they are in lines of work that could leave them vulnerable to being sued for malpractice, for example. Or they fear what will happen if their business has problems, or someone gets hurt on their properties. They might seek ways to protect their assets from court cases. They have insurance, but what if it’s not enough?
So they “strip” the equity, intending to leave very little value in the home that a court could attach.
But asset protection strategies can bring new risks, like the appearance of improper dealing. Homeowners who protect their property from legal action need to plan well in advance, before conflicts materialize. Transferring the home title outright, to avoid creditors, could be considered improper or even illegal. Laws that control credit and bankruptcy hinder equity stripping in some states, by limiting the amount of value that can be shielded from legal actions.
This means creditors could manage to force the homeowner to liquidate assets despite the other debts. If so, all that equity stripping will be in vain.
☛ Concerned about protecting the value you’ve grown in your home? Check out these five tips to protect home equity.
Deeding the Home to the Safer Spouse?
Some at-risk homeowners quitclaim the title to a spouse (or other close person) who’s in a position less vulnerable to monetary lawsuits. The strategy could backfire, as the spouse could interoduce a different set of liabilities, and the transfer could have tax consequences.
Accounting and estate planning professionals should be consulted before a homeowner makes any titling decisions to try to shield home equity.
The typical state law allows creditors to go after past-due debts by challenging the debtor’s asset transfers done in the past four years. If real estate was transferred in circumstances other than a standard listing and sale, a court might void the retitling under anti-fraud laws!
Nor will creating a spousal co-ownership arrangement shield the home. Creditors have ways to reach the property through the non-debtor spouse. This, in fact, is why spouses might vest their home as a tenancy by the entireties (TBE) in the first place.
☛ Learn more about tenants by the entireties, and other ways co-owners vest their ownership.
With TBE, if an obligation belongs to just one spouse, a creditor cannot put a claim on the co-owned property. That said, bankruptcy courts could use partition to “split” the property up or even foreclose it if they decide a fair and legal outcome requires this.
There are other potential surprises for couples who retitle their home equity from one to the other. What if the couple splits up? Or the spouse who’s protecting the value could die first. The real estate could then boomerang back to the original title holder.
HELOC: Flexible Tool to Control Home Equity
A popular, relatively cheap way to borrow against a home is to apply for a HELOC. That’s a home equity line of credit. The HELOC, a variable-rate credit line, encumbers the home deed, like a second mortgage. The HELOC credit line stays open until the homeowner officially closes the account and has the lender release the lien.
An applicant needs to declare a use for the funds — renovations, business goals, etc. — that would make the home more productive than it would be if equity were just sitting, untapped, in the home. Some homeowners use as much equity as they can. But there’s no obligation to draw any funds through the HELOC line. An unfunded HELOC could keep lawsuits at bay. But the homeowner still has dibs on its value. And the homeowner could still use the HELOC’s cash flow as needed.
HELOCs are famously flexible. Yet, like most other methods of tapping into equity, HELOCs take time and effort to get. Applicants are carefully vetted, and their homes appraised. The application process has plenty of hoops to jump through. There are fees and hazard insurance to be paid.
Potential Pitfall: The Friendly Lender
Some homeowners get financing from friends or associates. Or perhaps the friendly lender is the homeowner or the homeowner’s company. But courts may deem a friendly loan fraudulent. State law sets forth the rules on collateralizing homes. In general, a legitimate home loan must involve:
- A clear financial purpose. Reasons for loans may include business purposes, investing in the home itself, education, or even making investments. Some real estate owners decide to strip equity out of their homes and invest the funds in stocks. This can be a risky move, but it’s not uncommon.
- Proper documentation. And this does include a duly recorded lien on the home.
- Timely repayment. The borrower needs to be paying off the loan principal and interest, following the terms of a legally binding loan agreement.
A homeowner can also get some protection by applying for homestead exemptions where available. A homestead exemption has tax benefits. It also supports residents who face bankruptcy or the death of a life partner, by capping the amount of a home’s value available for attachments and liens. But this exemption doesn’t protect the majority of the home equity if the owner faces a financial lawsuit. For this reason, homeowners look for loan opportunities in addition.
Word to the Wise: Asset Protection Is a Tricky Business
Lowering risk in case of lawsuits could be a very wise thing to do. Equity-stripping is one option worth knowing about.
But it must be carefully done. If it isn’t, it can backfire in multiple, serious ways. The homeowner or buyer needs to sit down in advance with a lawyer. That lawyer should have solid expertise in asset protection strategies. Speaking with an insurance pro and an accountant is also important.
In short: Equity stripping can safeguard some of a home’s value, if done in a well-informed manner.
Supporting References
Federal Trade Commission Consumer Advice: Home Equity Loans and Home Equity Lines of Credit.
Randall A. Denha, Esq. for the Denha and Associates, PLLC Blog: Asset Protection-Equity Stripping Value (2022).
Randall A. Denha, Esq. for the Denha and Associates, PLLC Blog: The Do-It-Yourself Asset Protection Plan – Be Careful (2022).
Rebecca Baldridge for Investopedia.com (part of Dotdash Meredith publishing): Alternative Investments – Real Estate Investing – Equity Stripping Leaves Creditors Empty-Handed (updated Aug. 25, 2021).
SJF Law Group Blog: How Can Married Couples Protect their Assets from Creditors? (undated).
Deeds.com: HELOC – How Home Equity Lines of Credit Impact a Home’s Title (Jul. 30, 2023).
And as linked.
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