Equity stripping

Equity stripping, also known as equity skimming, is a type of foreclosure rescue scheme. Often considered a form of predatory lending, equity stripping became increasingly widespread in the early 2000s. In an equity stripping scheme an investor buys the property from a homeowner facing foreclosure and agrees to lease the home to the homeowner who may remain in the home as a tenant. Often, these transactions take advantage of uninformed, low-income homeowners; because of the complexity of the transaction, victims are often unaware that they are giving away their property and equity. Several states have taken steps to confront the more unscrupulous practices of equity stripping. Although "foreclosure re-conveyance" schemes can be beneficial and ethically conducted in some circumstances, many times the practice relies on fraud and egregious or unmeetable terms.^[1]

Term and definition

The term "equity stripping" has sometimes referred to lending refinance practices that charge excessive fees thereby "stripping the equity" out of the home. The practice more often describes foreclosure rescue scams. While most do not consider equity stripping a form of predatory lending per se, equity stripping is related to traditional forms of that practice. Subprime loans targeted at vulnerable and unsophisticated homeowners often lead to foreclosure, and those victims more often fall to equity stripping scams.^[2] Additionally, some do consider equity stripping, in essence, a form of predatory lending since the scam works essentially like a high-cost and risky refinancing. Equity stripping, however, is conducted almost always by local agents and investors, while traditional predatory lending is carried out by large banks or national companies.^[3]

Alternate Uses

In addition to the fraudulent uses described here, the term "equity stripping" also refers to the asset protection concept whereby the equity of an asset is encumbered, or stripped, to frustrate collection efforts by unsecured creditors. This can be done to protect the assets of individuals or organizations in high-risk businesses (e.g. doctors) from losing equity in lawsuit actions.^[4]

Market conditions

Trends in the United States economy have led to the growing market for foreclosure services and equity stripping. Property values have increased dramatically from 2000-2005.^[5] However, with an increase in values, foreclosure rates also peaked in 2001 and remained high,^[6] leaving numerous foreclosed homeowners with substantial equity. With these trends, a market emerged to tap into this equity.

Scam Elements

Foreclosure

A homeowner falls behind on his mortgage payments and enters foreclosure. Foreclosure notices are published in newspapers or distributed by reporting services to investors and rescue artists. Foreclosed homeowners also contact lenders to inquire about refinancing options.

Solicitation

Rescue artists obtain contact information for foreclosed homeowners and make contacts personally, by phone, or through direct mail. Some lenders and brokers will also refer foreclosed homeowners that do not qualify for new loans to rescue artists for a commission. Rescue Artists offer the foreclosed homeowner a "miracle refinancing" and/or say they can "save the home" from foreclosure.

Acquisition

Rescue artists arrange the closing (often delaying the date until shortly before the homeowner's removal to create urgency). At the closing, the homeowner transfers title (possibly unwittingly) to the rescue artist or an arranged investor. The rescue artist or arranged investor pays off the amount owed in foreclosure to acquire the deed, and inherits or is paid any portion of the homeowner's remaining equity. The rescue artist will reconvey the property back to the homeowner in the form of a lease or a contract for deed.

Result

The homeowners remain in the home and pay rent or contract-for-deed payments (often higher than their previous mortgage payments). They inevitably fall behind, and are evicted from their homes with very little of their equity.

Legal Remedies

Several states have passed laws to prevent and/or regulate equity stripping schemes. Minnesota passed a comprehensive law aimed at "foreclosure re-conveyance" practices in 2004, and Maryland in 2005 was the first of at least 14 other states to adopt the Minnesota model for regulating these transactions.^[7] These state laws require adequate disclosures, capped fees, and an ability to pay on behalf of the consumer. The statutes also ban certain deceptive and unfair practices associated with equity stripping.^[8]

Other laws regulating the activity of "foreclosure consultants" have been passed in California, Georgia, and Missouri.^[9]

Additionally, state fraud and unfair and deceptive trade practices laws may be applicable.^[8] The Truth in Lending Act may also govern some transactions.

Non-Predatory Foreclosure Rescue

In certain circumstances, foreclosure rescue services can be beneficial to the consumer. When refinancing options are exhausted and foreclosure proceedings have led to near eviction, a foreclosure rescue transaction with moderate fees and full disclosures can be legally and ethically executed.

A consumer can face removal from the property and the loss of their entire equity following a foreclosure auction. As an alternative, foreclosure rescuers have the ability to redeem the home from foreclosure with a new mortgage of their own. For a moderate fee or portion of the existing equity, this can keep the former homeowner in the home as a tenant while they repair their credit or increase their income. After a given time period, the homeowner can then repurchase the property from the rescuer.

If done with full verbal and written disclosure, terms the consumer is capable of fulfilling, and moderate total fees, foreclosure rescue can be suitable to consumers in dire situations.

This mechanism is often used by family members or friends in order to prevent the loss of a home. In effect, the investor "lends" their good credit to the foreclosed homeowner by paying off the foreclosed mortgage and obtaining the title to the home temporarily.

References

1. "New Scheme Preys on Desperate Homeowners". New York Times. July 3, 2007. With the housing market in decline, financial predators are finding yet another way to take advantage of people who fall behind on their payments. Shakeela Muhammad signed up for a mortgage program to save her home. The company stopped making payments, and she faces foreclosure. The schemes take various forms and often involve promises to distressed homeowners of cash upfront, free monthly rent and a chance to retain their houses in the long run. But in the process, someone else takes over the deed, borrows as much as possible against the value of the house and pockets the cash. And, almost always, the homeowners still end up losing their homes.
2. Allen Fishbein and Harold Bunce, "Subprime Market Growth and Predatory Lending," 277 (HUD Publications 2001)
3. Steve Tripoli and Elizabeth Renuart, National Consumer Law Center, "Dreams Foreclosed: The Rampant Theft of Americans' Homes Through Foreclosure 'Rescue' Scams (2005), available at www.consumerlaw.org/news/content/ForeclosureReportFinal.pdf
4. Equity Stripping Overview, http://www.rjmintz.com/equity_stripping.html
5. Office of Federal Housing enterprise Oversight, House Price index for the Third Quarter of 2005, at 24(Dec. 1, 2005), available at www.ofheo.gov/media/pdf/3q05hpi.pdf
6. Office of Policy Development and Research, U.S. Department of Housing and Urban Development, U.S. Housing Market Conditions-3rd Quarter 2005 at 74 (2005)
7. See Minn. Stat. 325N (2004); Md. Code Ann., Real Prop. 7-301 to 7-321 (2005)
8. Prentiss Cox, "Foreclosure Equity Stripping: Legal theories and Strategies to Attack a Growing Problem," Clearinghouse REVIEW Journal of Poverty Law and Policy, 607-626, March–April 2006
9. Cal. Civ. Code 2945-2945.11; GA. Code Ann 10=1=393(b)(20)(A)(2005); Mo. Ann. Stat. 407.935-.943 (2005)