Equity stripping is an investment strategy where an asset owner continually borrows against or continually transfers the equity in an asset, therefore making it worthless to potential attorneys initiating legal proceedings to recover a judgment or to make the asset unattractive to creditors seeking payment due to defaults. Essentially, the method works by transferring the majority of interest in the asset to a third party, while the holder of the asset uses the funds exchanged for the equity to make other investments. Successful reinvestment of the funds paid to transfer the equity is meant to outperform the interest payable on the equity loan. This allows the asset holder to have control over the cash flow associated with the asset, while retaining usage of the asset. Most often, asset stripping is leveraged on mortgaged properties or properties owned outright.
Protecting the asset to retain usage rights is sometimes the main concern when leveraging equity stripping. There are several ways to accomplish this, but it almost always boils down to transferring the equity to another party for cash. Mortgage lines of credit are one way this is accomplished, while transferring ownership to someone else is another way, such as by signing the asset over to a spouse — referred to as spousal stripping. While often used as a tactic to avoid creditors, however, equity stripping is also an effective form of investing.
Businesses in particular can benefit from equity stripping to help protect assets against potential lawsuits, through what is known as an equity reduction plan. Additionally, equity is often considered unproductive if sitting idle; therefore, the equity does not contribute to the business in a proactive manner. Aside from property, businesses also have equity in accounts receivable, inventory, patents, trademarks and equipment. Transferring the equity in these assets allows the business owner to leverage the equity in the form of cash to make other investments, such as growing the business, while at the same time making these assets appear worthless in the event of legal proceedings. Additional individuals and entities having a majority interest in such assets complicates the process of securing a judgment against those assets, and in many cases makes it impossible.
Advanced planning, however, is essential for equity stripping to work effectively. Individuals or businesses attempting to leverage the techniques after initiation of legal proceedings will usually face charges of fraud from the court and will likely lose the usage of the asset as well as incurring criminal proceedings. Planning the strategy in advance can benefit both businesses and individuals by keeping equity constantly working to accrue more wealth for the asset owner.