In this episode of Coffee with Carl, attorney Carl Zoellner explains the basics of equity stripping and how this strategy can be useful to deter potential lawsuits.
Updated September 3, 2020
I get a lot of questions about equity stripping. So, let’s discuss what it means to strip the equity out of a property and when this may be a useful strategy to consider.
When we talk about equity, we’re most often referring to real estate, whether that real estate is a personal residence or an investment property. Regardless of what type of property, “equity” refers to the amount that, if you sold the property at its current estimated value, would come back to you as cash. Thus, equity means whatever portion of a piece of real estate you own minus any debt on the real estate.
Equity is of interest to plaintiffs’ attorneys. Attorneys look at the equity you may hold in a given property if they’re considering suing you. Evaluating your equity helps potential attorneys determine how much they could get from you in the event of a judgment. There are some nuances depending on whether the equity is held in a personal residence or an investment property. Personal residences have some level of equity protection based on the homestead laws of the state wherein the residence is located. The level of protection offered varies from state to state. Some states offer next to no protection, while some states will protect the full value of the equity in the personal residence.
Equity stripping is a useful tool because you can make your property (regardless of whether it’s your personal residence or an investment property) less attractive to potential creditors and plaintiffs’ attorneys. This is achieved by making the equity in the property disappear. Equity stripping is almost the same as a mortgage or deed of trust. Both are simply liens on a property, making it appear encumbered with debt.
HELOC or Cash-Out Refinance
There are a couple of routes you can follow to use this strategy. If you have equity in the property and want to access the cash, you can go the HELOC (home equity line of credit) or cash-out refinance route. In this scenario, the bank strips the equity from the property by lending you the cash value. If you don’t want to go through a bank or aren’t concerned with actually accessing the cash, the second route is to use a friendly lien.
In this scenario, you can go to the county recorder’s office to file a lien against your own property. In doing so, you remove the equity. This means there would be loan documents associated with the property, just like in a mortgage situation. The main difference between a friendly lien and a mortgage, however, is that you can act as your own lender within your own entity structure in a friendly lien scenario. Thus, if someone pulls a title report to see what you own, a friendly lien makes it look like the property’s equity is already claimed by another creditor. This signals to a potential plaintiff’s attorney that, should they choose to sue you, the attorney would be second in line behind the holder of the lien in order to collect a judgment. Ultimately, using equity stripping through a friendly lien or a HELOC makes the property much less attractive to plaintiffs’ attorneys.
There’s one more thing to be said about friendly liens. If you’re going to put a friendly lien on a property and aren’t planning for any actual money to change hands, the court system will most likely set that lien aside in the case of an actual lawsuit. So, friendly liens are more of a smokescreen. Using a friendly lien works to deter potential lawsuits before they happen by making yourself look like an unattractive target. With a friendly lien, if someone looks from the outside, it appears as though the property is already encumbered.
This strategy can be used as “attorney-be-gone.” It’s a smokescreen deterrent, but most likely will be set aside if an actual lawsuit takes place. In most cases, the equity stripping should be enough to deter potential lawsuits because there’s no apparent gain for an attorney to pursue you without equity. As all attorneys know, there’s a big difference between getting a judgment and actually collecting on that judgment. Use equity stripping to make yourself less of a target before a lawsuit even occurs.
Watch as Carl demystifies equity stripping as a way to deter lawsuits.
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