Equity Stripping For Real Estate Investors

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Unfamiliar to those without ample experience investing in the real estate industry, equity stripping is a strategy few know about, but many could benefit from. As a form of asset protection, stripping an asset of its equity will witness homeowners borrow against the equity in it, not unlike a home equity line of credit (HELOC). In doing so, the asset becomes significantly less attractive to creditors with malicious intentions, hence the asset protection designation.

Creditors are much less likely to be interested in a property without any equity. As a result, stripping equity has become one of the easiest ways to protect an asset; in rendering it less valuable, it’s less likely to attract litigation in any way. It is worth noting, however, that there are exceptions and risks associated with this strategy. Consult a legal professional before taking any action on your own. An equity stripping asset protection strategy can be well worth your time, but it needs to be done right.

What Is Equity Stripping?

Equity stripping is a relatively crude way of explaining a simple asset protection strategy. The process refers to reducing the amount of equity a homeowner has in their property. A HELOC, for example, is recognized as a form of equity stripping, as borrowing against the property’s equity diminishes the homeowner’s equitable interest in it. In doing so, the property becomes less attractive to anyone who may have an interest in making any claims against the property. If for nothing else, the less attractive the home’s position looks, the fewer people will be interested in taking it. That said, stripping equity isn’t only a great method of asset protection, oftentimes it’s the only means of protecting an asset.

The theory behind equity stripping is rather simple: in limiting the amount of equity in a subject property, creditors and traditional lending institutions won’t go through great lengths to levy any claims against it. As Investopedia puts it, “owners can retain control over the cash flows and use of the asset while making the property unattractive to creditors attempting to administer some type of legal judgment.”


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Equity stripping asset protection

The Types Of Equity Stripping

There are several ways to strip a physical real estate asset of its equity, but there are two forms which are more common than all of their other counterparts: spousal stripping and home equity lines of credit. Both types of equity stripping strategies serve a similar purpose, but they are to be executed under different circumstances.

Spousal stripping, as its name suggests, will have the debtor transfer ownership of the property over to their spouse (who presumably has less debt). Transferring a title from one distressed spouse to a less-distressed spouse allows the original debtor to file a quitclaim to the property in the name of subsequent spouse. The quitclaim suggests the original debtor didn’t have valid ownership over the asset and releases them from the interest in the property. While a quitclaim is a viable form of equity stripping, it is by no means guaranteed to work. Those considering need to acknowledge this simple asset protection strategy comes with some caveats before attempting to carry it out.

Homeowners may also take out a home equity line of credit to protect their assets. Otherwise known as a HELOC, a home equity line of credit is a line of credit homeowners may take advantage of by borrowing against the equity in their homes. Using the home as collateral, owners may borrow against the equity they have managed to build. In borrowing against the equity in a home, the owner is stripping away the equity. As a result, creditors will find the asset less worth their time, and perhaps grant the owner a little leeway.

Equity Stripping Example

As a foreign concept to many, stripping a home of its equity isn’t easy to comprehend. Not only are there several ways to strip a home of its equity, but the circumstances surrounding the homeowner may also complicate things. That said, an equity stripping example may go a long way in clearing things up.

Let’s say, for example, a homeowner manages to build a $100,000 equitable stake in a $500,000 home. To be clear, that means the borrower has about $400,000 left in mortgage obligations (less any additional interest incurred over the life of the loan). In addition to being able to claim an exemption on the equity, the homeowner may be able to borrow against it. Using a HELOC, the homeowner in this situation may tap into their equitable stake and use it as a $100,000 line of credit; they are using the equity in their home as a loan. However, in doing so, the owner is simultaneously draining the value of the asset. If enough equity is stripped, the asset may extend beyond the reach of predatory litigation against the distressed homeowner. In other words, it’s not worth it for creditors to come after assets without enough equity.

Equity Stripping Asset Protection

As I already suggested, equity stripping represents an opportunity to protect an asset, not unlike an investment property, which begs the question: how does the process work? The answer isn’t nearly as complicated as many would assume, but still worth paying attention to.

This strategy will witness a homeowner make their asset less attractive to future creditors that may come for the property at a later date. In doing so, homeowners will go the extra mile to “encumber” their assets with one or more liens. And while doing so may sound counterproductive, it can be quite effective. You see, in levying a lien against your asset, you can protect it from scrupulous creditors.

A lien levied against your property from a creditor is bad news; it could very easily jeopardize your asset. However, if the lien is of your own doing, it can be extremely useful in protecting your asset. If for nothing else, a lien placed on the property will take precedence over any subsequent liens, with very few exceptions, of course. Therefore, if you place all of the equity in your home in an existing lien, then all future liens placed on your property will essentially be worthless to their holders. Simply put, your lien will render any creditor’s liens moot.

There are exceptions to the rule, of course. Equity stripping won’t always work. Tax liens, for example, will trump any lien you can levy against your property, and ruin any chance you have at protecting your asset. Therefore, consult a professional who is well-versed in real estate law before taking any action of your own.

Benefits Of Equity Stripping

Investors able to take out a HELOC should be able to take advantage of the primary benefits of equity stripping as an asset protection strategy. As perhaps the most common form of asset protection, a HELOC will allow homeowners to strip the equity out of their home while simultaneously retaining access to a portion of the funds. If for nothing else, a HELOC will give you access to the equity in your home, whether you need it or not. As a result, creditors won’t see the value in coming after your home, as it has already been taken up the HELOC that you currently hold. That way, you have access to the equity (like a credit card) and the creditor doesn’t.

In addition to a HELOC, a home equity loan will allow homeowners to tap into their equity. With this technique, you are going to get the entire amount of your equity in cash upfront, but with a caveat: you’ll have to start making payments immediately because this type of loan puts the money in your hands the instant you decide to follow through with it.

Each of these strategies can stymie creditors by making the subject property less appealing. What’s more, they give you access to the equity that was previously in the home.

To sum things up, the benefits of equity stripping include:

  • Creditors are less likely to pursue the subject property if the equitable stake isn’t large enough. For creditors to come after a home it needs to be worth their while, and taking equity out of it may turn them off of the idea.

  • A HELOC may give homeowners access to the equity, but they don’t need to use it. That way, the HELOC is essentially acting as a shelter for the equity; one that doesn’t create additional debt and hides the equity from debtors.

  • Investors can use traditional LLCs to strip equity and make their assets less appealing to creditors.

Disadvantages Of Equity Stripping

Equity stripping has proven itself a valuable tool in protecting homeowners and businesses. However, when executed with anything less than a mind for due diligence and complacency, homeowners can run into a lot of complications. While a valuable tool in many toolkits, investors must also acknowledge the disadvantages of equity stripping:

  • The tax consequences of stripping equity may prove significant. As a result, homeowners will want to consult a CPA before they even think about stripping the equity from any of their assets.

  • Interest rates can be extremely high on loans used for equity stripping.

  • HELOCs, in particular, use the asset as collateral, so homeowners need to know exactly what they are getting into. Any issues that arise could result in the loss of the home.

Summary

When executed to perfection, and as a complement to a well-crafted strategy, equity stripping can serve to protect your real estate assets. More importantly when coupled with a limited liability company (LLC), stripping equity can simultaneously protect your property and yourself. However, equity stripping is not without risk, and it can get quite confusing to those that have never done it before. Therefore, it’s important to work with a legal real estate professional before making any moves of your own.


Key Takeaways

  • Protecting one’s assets from malicious litigation is made possible through equity stripping real estate strategies.

  • Equity stripping asset protection comes in many forms, not the least of which may be a home equity line of credit.

  • Sheltering equity is more common than most new investors realize.