|By David Pilley on September 21, 2010
Any piece of property you own has equity, or a certain amount of worth in dollars minus the amount you owe. (Here’s a basic example. If your home is worth $150,000, you had a down payment of $30,000, and you have borrowed $120,000 for the mortgage, your current home equity is $30,000. As you pay the rest of the mortgage, the equity goes up.) Therefore, a home equity loan would be a secured loan using your home’s equity as collateral. If you default on this type of loan, your home’s equity gets taken away.
This type of lending is an example of equity stripping, and it can have major consequences if done improperly. It could be a salve, or it could be a scam. To prevent risk of foreclosure, a homeowner might consider using a form of equity stripping to make it seem like the property has no value; therefore, outside lenders will not pursue a legal judgment against it.
The most common type of equity stripping is called a home equity line of credit (HELOC). With this action, your lender will place a lien against your home’s equity, and you retain control of cash flow and use of your home. (Of course, when a lender places a lien on your property, you can’t move, and you can’t try to sell it. You are stuck there until you pay back the loan.) A HELOC uses a line of credit, in which you repay the loan (plus interest) in a monthly payment plan. The interest rate is variable, though, so the total amount of money you have to pay could go up unexpectedly. In some states, the interest on a HELOC is tax-deductible, so this has been a popular type of loan in the past decade.
However, equity stripping does not necessarily protect you from foreclosure. This action is typically done to protect from predatory lenders, but that doesn’t mean your own lender won’t take legal action. Remember, your lender has a lien on your home, meaning he/she has a claim of ownership. If you can’t make the timely payments you agreed to pay, the lender can repossess your home, and you may be evicted. As it is a type of asset protection strategy, you should consider equity stripping only if you can make the payments. (There is no protection if you can’t afford it, after all.) Lowering the equity on your home to protect against foreclosure could ultimately backfire if you don’t do it right, and in the end, you could end up not just with no equity, but also with no home.