What is Equity Stripping?
Equity Stripping is a collection of methods created to decrease the overall equity in a property. Equity stripping strategies can be utilized by borrowers as ways of making properties unappealing to lenders, along with predatory lenders wanting to benefit from homeowners who face the possibility of having to foreclose on their property.
Whether you want to protect an individual home or financial investment property, you need to recognize that lenders do not go after the property itself, but the equity in the property. Lenders need to foreclose on the property, which suggests the property will certainly be sold by a sheriff. On the foreclosure sale, after the settlement of the secured liens (like a home mortgage), after paying the sheriff’s costs, as well as after paying the homestead exemption amount to the borrower, the remaining equity will go to the lender. Subsequently, it is the equity that gets converted into money and given to the lender. Not the property itself.
If the property has no equity, then the lender will not obtain any cash sum from the foreclosure sale. As an example: Your house is worth $2,000,000 and is mortgaged to the tune of $1,800,000. You reside in California and your homestead exemption is $75,000. The house has to be presented in a foreclosure sale, where it is eventually sold for $1,900,000. Of the $1,900,000, the initial $1,800,000 will go to the bank to settle the mortgage. After that, some of the money will go to pay the sheriff, and after that $75,000 will go to you. There is absolutely nothing left for the lender.
A smart lender will be able to do the math beforehand and will attempt to force a home in these circumstances into a foreclosure sale. In fact, many lenders will certainly drop their legal action if they come to terms with their situation and realize there is no equity left in their property to pursue. As a result, many borrowers will look to eliminate (strip out) their equity.
There are two equity stripping techniques:
- Actual Bank Loan
- Paper Strip
Actual Bank Loan
Obtaining a bank loan is one method of stripping the equity from a property. The bank will protect the loan by recording a deed of trust against your property. This removes the amount of equity that is equal to the amount of the loan.
While this method leads to the removal of equity, two problems are presented. First, it is hard to get a bank loan that is sufficient enough to eliminate the equity completely. Second, the amount of money required to pursue this form of asset protection is way too large for most people. Let’s say a $2 million loan has a 5% rate of interest, the equity strip cost is $100,000 each year. (Borrowers normally try to alleviate the excessive costs by investing the proceeds at an equivalent rate of return.)
Paper Strip
An additional method is to strip out the equity (regularly promoted by borrowers), to restrict the home by recording a deed of trust in favor of a close friend.
This prevents having to bear the additional cost of a loan and it can cover any amount of money. With this strategy, it is essential to have an insight into how knowledgeable and aggressive the lender is. Some lenders might quit attempting to accumulate when they realize there is no equity in their home. Others might dig much deeper, and also if the borrower cannot corroborate the transaction as a real loan, then the court will deem the deed of trust as a sham and will set aside the deed. The lender will once again have equity to pursue.
Exemption Laws
You cannot always totally depend on the exemption laws, or that your assets are entitled to several protective entities. Your objective is to convert your debt-free into debt-ridden assets that will be worthless to a complainant.
You achieve this with various types of mortgages as well as liens. A lien is a mortgage or security interest submitted against a borrower’s property or personal effects. As the homeowner, you own the home, however, you transfer the financial value of your home to the mortgage holder. This lowers your equity in your home as well as the equity your lender or plaintiff can seize.
It is pretty easy to understand. If your home is worth more than what you owe on the mortgages (or liens) against it, you have equity in your home for your plaintiff to claim. To secure your home, you would lower (or strip) your equity by raising the mortgages or liens against your home. This method is easy; however, some terms might make it more complicated.
No doubt you are familiar with mortgages – a voluntary lien on real estate to protect a financial debt that you owe. Some western states call it a deed of trust. Rather than providing the lender with a mortgage, the borrower deeds the residential property to 3rd party trustee. The borrower can live in the residential property as long as the financial debt is paid. The only difference there is between a mortgage and a deed of trust is that a trustee can offer your residential property for sale at public auction if you default on your payments. Whereas, if a mortgage holder wants to auction your property, they have to foreclose your property through a court.
There is a different set of terminology that applies to personal property. A lien on personal property is a security agreement. You might be able to secure your debt by pledging your personal property as security. It is feasible that the secured party will keep hold of your personal property (i.e. pledging your family silver to a pawn shop). What usually happens is that the borrower will continue to have the collateral. A notice of lien (a financing statement) needs to be filed in a public recording office so that third parties will realize that the property is not available.
You can place numerous liens against one property. The priority of each lien is then established by when they were entered into the public records.
The point is that when you have legitimate liens a plaintiff can only take the amount of equity you have in the property. To ensure that you are protected you need to have as little or no equity exposed. Your $500,000 house with a $500,000 mortgage is worth absolutely nothing to a plaintiff. Your objective is to ensure that all assets are worth absolutely nothing to any plaintiffs.