Equity Stripping

Equity-stripping is perhaps the best technique available to protect real property from creditors, so we’re told. The theory behind equity-stripping is, very simply, that if you don’t own any interest in the property (i.e., the equity is “stripped” out) there is nothing for a creditor to get, and so therefore a creditor will not spend the time and money to attempt to execute on the property.

As with most asset protection techniques, equity stripping works best when it is done in a “quiet period” in advance of any creditor claims (i.e., the transaction is “old and cold” by the time the creditor comes knocking at the door). However, there are some ways, with more expense and risk, to make this work in case of a creditor attack.

Spousal Stripping

This is the most common technique; it is also the worst. Here, you simply quit-claim over to your spouse your interest in the property.

Advantage: Cheapest way to do this.

Disadvantage: Most creditor attorneys are knowledgeable of this technique, and look for it.

Disadvantage: You spouse may divorce you, leaving you with no interest.

Disadvantage: A court may consider this to be a fraudulent transfer and merely ignore it.

Uncontrolled Bank Stripping

Taking a (first or second) loan from a bank is the easiest and most common way to equity-strip property. You now have the cash, which being liquid is much easier to protect from creditors than real property, and when the cash is invested it will hopefully grow at a rate higher than your mortgage interest and associated mortgage costs.

Advantage: You can get a home-mortgage deduction.

Advantage: Not likely to be considered a fraudulent transfer, if the bank has no notice of any pending claims or judgments against you and no lien has been filed against the property.

Advantage: Creditor has to consider whether or not any equity will be left over from liquidation of the property, since the creditor is second in line and will not receive a penny until the first mortgage is paid off and all expenses of liquidation and sale are paid.

Disadvantage: You essentially surrender control to the bank. If you don’t make payments to the bank on the note (keeping in mind that you will probably be denying to a creditor that you are liquid), they bank will foreclose whether or not you desire foreclosure.

Disadvantage: The bank probably will probably only give you a loan for 80% of your equity (since the bank will be concerned about fluctuations in property value and liquidation costs), so you will probably leave 20% unprotected. If the creditor forces liquidation, you will lose this unprotected equity and any apprciated value.

Disadvantage: If your liquid cash derived from the loan does not grow faster than your mortgage rate plus costs, then economically you will be a net loser.

Controlled Bank Stripping

The best way to equity-strip property is use a controlled entity to fund or back the bank’s loan.

Advantage: You can get a home-mortgage deduction.

Advantage: You indirectly maintain complete control on whether the property will be sold to satisfy the mortgage.

Advantage: Since you are backing the loan, you can structure the loan on default so that it “balloons” to effectively eat up the rest of your equity and any appreciated value of the property, and thus protect that value too.

Advantage: If performed correctly, Creditor sees only loan to bank. Creditor sees that there will be no moneys remaining after liquidation, so unless the Creditor is just plain stupid or spiteful will not even pursue a sale of the property.

Advantage: Since the liquid assets derived from the loan are backing the loan, you are not subject to market whims.

Disadvantage: It is more costly to set up this backing arrangement.