You’ve saved forever to buy your dream home. And now that you own the roof over your head, you certainly don’t want to risk losing it all in a lawsuit or to creditors.
As scary—and impossible—as that sounds, it’s an all-too-real possibility. According to recent figures, Americans file about 40 million lawsuits every year. So what’s a common scenario that could put a homeowner before the court?
Let’s say you’re getting roofing work done when the roofer trips and falls on your property. The roofer then sues you for financial compensation due to an injury—whether he is hurt or not. If a substantial judgment comes down against you, you could lose your home.
“So knowing ahead of time on how to protect your home from a lawsuit is essential,” says Scott Gizer, an attorney with Early, Sullivan, Wright, Gizer & McRae in Los Angeles.
Beyond the uncertainty of litigation, creditors could come after your property if you or your partner face unexpected financial hardship due to a sudden job loss or illness.
So here’s what precautions you can put in now to safeguard what is likely your most significant and valuable asset—before it’s too late.
How to protect your home from lawsuits
General liability coverage: All homeowners should have this standard coverage.
“Homeowners need general liability coverage on their homes so that they are protected should someone be injured on their property, or from other possible claims,” says John J. Perlstein, a personal injury attorney in Beverly Hills, CA. “This protects not only the equity in your home but other assets that could be lost should a claim arise.”
Just be sure to stay up-to-date on property taxes since defaults suggest that the homeowner isn’t taking proper care of their property, adds Gizer. Any hint of negligence could make you look bad in court should a lawsuit arise.
Umbrella insurance: Umbrella insurance goes above and beyond the coverage provided by standard insurance liability policies.
“An umbrella policy is important as some insurance claims can exceed primary limits,” says Perlstein. “And the cost of an umbrella policy is relatively little for the protection it provides.”
For instance, you could be involved in a car accident where one of the parties sues you for more than what your car insurance covers. The right umbrella insurance policy will ensure no one can take your home.
How to protect your home from creditors
Homestead exemption: So what if, instead of a lawsuit, you’re facing a creditor or bankruptcy? A homestead exemption is available in certain states and protects some of the value of your home if a creditor forces the sale of your property. Some states allow an unlimited exemption, but other states set a cap on that amount.
“A homestead exemption usually only applies when creditors are coming after you,” says Gizer. “In California, $75,000 to $150,000 in equity is insulated from creditors.”
A creditor will then collect what’s left after selling costs, complete mortgage payment, and your homestead exemption amount.
Tenancy by the entirety: Tenancy by the entirety allows a married couple to carry equal interest in a property and the right of survivorship. The benefit of this legal agreement is that if a creditor sues one spouse for an unpaid debt, creditors cannot go after the property. Creditors can only pursue a lien on a house if the debt is in the names of both spouses.
Equity stripping: Equity stripping is a strategy to protect your home by saddling it with one or more liens. This strategy reduces the value of your asset. And the easiest lien to put on your house is a loan in the form of a home equity line of credit, or HELOC.
“However, equity stripping requires skill to execute properly and is costly,” says Grizer. But if done right, equity stripping can be a good option when it comes to protecting your property.
The trick is in the implementation of the loan, according to Mark J. Kohler, a certified public accountant, author on asset protection and tax planning, and partner at the law firm Kyler Kohler Ostermiller & Sorensen, LLP.
“A traditional HELOC or first mortgage lien is usually a good fit. And it’s tough for a creditor to challenge equity stripping in court,” Kohler writes on his blog.
Domestic Asset Protection Trust: More than 15 states have DAPT laws. A DAPT is an irrevocable trust that allows the trust’s settlors to be discretionary beneficiaries—i.e., a beneficiary who can benefit only at the trustee’s discretion. This designation shields those beneficiaries against claims from the settlor’s creditors. In other words, the trust can protect assets from any future creditors or lawsuits against you once you inherit the property.
“Typically, you would place any personal residence, cabin, beach house, or a farm you plan on keeping for life in this type of trust,” writes Kohler. “The longer you keep the properties in the trust, the better protection they afford.”
To find the best route to protect your assets, research your state laws and consult with asset protection professional.