What Is Equity Stripping?
Equity Stripping is a set of strategies designed to reduce overall equity in a property. Equity stripping strategies can be used by debtors as means of making properties unattractive to creditors, as well as by predatory lenders looking to take advantage of homeowners facing foreclosure.
- Equity stripping is an asset protection practice in which assets are protected by distributing interest in it to multiple parties.
- It is also considered a predatory lending practice because it helps creditors reduce an owner's claim to a property by systematically purchasing equity in it and controlling cash flow associated with the property.
- Spousal stripping and HELOC are two of the most common forms of equity stripping.
Understanding Equity Stripping
Equity stripping is seen by some as one of the simplest and most successful methods of asset protection against creditors, while others view the tactic simply as a form of predatory lending.
The idea behind equity stripping as an asset protection strategy is that through reducing interest in a property, creditors are discouraged from including the property in any claims against the debtor. By giving another party a claim against a property, an owner can retain use of the property as well as control over cash flow while simultaneously making the property an unattractive asset to any creditor who may otherwise attempt to exercise a legal judgment against the property owner.
As a predatory lending mechanism, equity stripping is exercised against homeowners facing foreclosure. An investor buys the property from the homeowner under threat of foreclosure and agrees to lease the property back to the former owner, who may then continue to use the property as a residence. Predatory investors often use this method to take advantage of property owners with limited resources and information.
Forms of Equity Stripping
In addition to the strategies employed by predatory lenders, two of the most common equity stripping strategies are spousal stripping and home equity lines of credit (HELOC).
Spousal stripping is the process of shifting the title of a property into the name of a debtor's spouse. This strategy allows a debtor to file a quit-claim to the property in the name of their spouse, who presumably has no debt or little debt. While this strategy is not a bulletproof method of protecting property from creditors, it is a simple and accessible asset protection strategy for many homeowners managing significant debt.
Home equity lines of credit enable the owner to use the equity in their home as a line of credit. A HELOC is a sort of a second mortgage, using the home equity, or the difference between the value of the home and the remaining mortgage balance, as the collateral on a line of credit. Funds in a HELOC function in similar ways to a credit card. The bank issuing the HELOC to a homeowner will provide a number of avenues for using these funds, including a bank-issued credit card tied to the account. While HELOCs offer some attractive benefits, including variable interest rates and, in some cases, low or no closing costs, they can also put borrowers in jeopardy of losing the equity in their home.
Example of Equity Stripping
Suppose a home is worth $500,000 and the owner can claim an exemption of $100,000 from the property. Without a mortgage, a creditor to the home owner could place a lien on the home amounting to $400,000, i.e., the remaining less than the tax exemption. With a mortgage, however, the creditor will not be able to place a lien for that amount due to the security interest that the lender of the mortgage is entitled to.