Real estate prices have been going up non-stop since 2008. Look at how the median sale price for the entire USA has climbed (data from Zillow):
In some high demand areas like San Francisco and New York, the chart is even steeper. We see more and more families having significant equity accumulated in their home and questioning how to protect it. We know that letting house equity just sit is a bad financial decision from an investment point of view and one of the reasons rich people never pay off their house. Today we want to talk a little about its protection.
Picture an old churchgoer tripping on your driveway while trying to deliver a magazine and breaking a hip. Picture your beloved kid with a freshly minted driver’s license hits a pedestrian. Picture yourself having a party in your house and a guest’s toddler rolls down the staircase as his mom was a bit tipsy. In all three cases the very next call you get maybe from a lawyer checking how much you are worth and what kind of insurance you have. If you have assets you are certainly at risk of a lawsuit against you, and the more assets you have the more you are at risk. If you think that asset protection is only for the rich and are not counting your home equity as an asset, think twice.
Rich people use Irrevocable Trusts to build a wall around their assets. Irrevocable trusts are more complicated arrangements than simple revocable trusts. Irrevocable trusts have a current and future tax implications, usually implemented offshore, can be expensive to establish and maintain. We think that such an ultimate level of asset protection is overkill for a regular family. There is a much simpler, more understandable and FREE technique called Equity Stripping. Rich people also use this technique to their advantage. Here how it works.
Let’s say you own a house valued at $500K with a remaining mortgage balance on it of $200K. You own $300K of equity which makes zero interest and is 100% at risk. To strip yourself of equity you would do a cash-out refinance for $400K ($200K to pay off the previous mortgage and $200K cash out). Now the bank owns $400K of your house and you own $100K with $200K in your checking account. A lawyer going after equity in your house will see $100K rather than $300K. Moreover, in some states, part of your home equity is protected from creditors and lawyers. This leaves little or no target for a lawyer to go after! In California, $75-$175K (depending on marital status and age) of your home equity is protected by state law which makes your home 100% protected in the above case. Isn’t it genius?
But wait, what about that $200K sitting in your checking account? Shouldn’t you protect it too? And what about the increased mortgage payments? Before you were paying off a $200K loan balance while now you have a $400K loan balance. Yes, you are right on both accounts. This money needs to be invested in financial instruments protected from creditors, losses, and lawyers, and it must be earning interest above of what you pay for the mortgage. Depending on your needs and residence, these could be Fixed Index Annuities, Index Universal Life Insurance, some state pension plans or others. Please consult your local professional specialist to see what is available to you.
Let’s assume your new mortgage is at 4% and your annuity (or other investment) makes 6%. In that case, you are essentially making 2% on $200K from day 1. That is $4K a year. Don’t forget that this 2% is compounding! In the above scenario your $200K compounds to $700K in 30 years! Not a bad check written to yourself for protecting your home equity, right?
Cash is king, knowledge is everything.
Wallio: from Wallet to Portfolio