!!! UPDATED IN 2023: PLEASE READ MY 2023 POST FOR AN IMPORTANT UPDATE !!!
On January 1st, 2022, Arizona’s homestead exemption will rise from $150,000 to $250,000. Generally, what this means is that $250,000 of equity in your home will be protected from creditors. Conversely, any equity above $250,000 will be fair game in the event you are sued.
In my case, I recently paid off my mortgage. (Mortgage Free. Tetelestai!). Zillow estimates my home value at $480,000, and we’ll use that valuation for our purposes, here. Let’s say I’m sued after allegedly causing a terrible pileup on I-10, and my automobile insurance coverage is not enough to pay all property damage costs, medical bills, and other damages. The successful plaintiff would then go after the equity in my home that was not protected by the homestead exemption: $230,000 ($480,000 equity – $250,000 homestead exemption). The plaintiff might obtain a lien against my home for the unprotected equity. Worse, the plaintiff might force the sale of my home, in which case I’d get $250,000, and the plaintiff would take the rest. I’d be out $230,000 and be homeless!
If you have a mortgage on your home, the same analysis applies. Let’s say you just bought your home for $500,000 and put 20% down. You have $100,000 in equity. That is less than the $250,000 homestead exemption so your home would be protected. However, let’s say a few years have passed since you bought your house, including the crAZy pandemic period when real estate prices went gangbusters, and your house has appreciated to $850,000. So you have about $450,000 in equity ($350,000 appreciation + $100,000 down). That leaves $200,000 available for a plaintiff to pursue ($450,000 equity – $250,000 homestead exemption). Long story short: the plaintiff could force the sale of your home, cut you a check for $250,000, and pocket the rest of your equity while you go looking for a new place to live.
What to do? One answer is keep enough leverage on your property so that you never have more than $250,000 in equity. That is a legitimate approach in some respects. Then again, by keeping a large mortgage on your home, you are putting yourself at risk in other ways because you are always a few payments away from having the bank come take your home. Recall the Great Recession not that long ago: many people endured pay cuts, lost jobs, shuttered their businesses, watched their 401ks and IRAs get annihilated, and couldn’t make their mortgage payments. Selling their homes didn’t help them because real estate prices collapsed, and their loans went underwater. They got wiped out and lost their homes in foreclosure. No thanks.
Another option is to live in a home that is free and clear and well under $250,000 in value. In this way, you’ll keep yourself under the homestead exemption cap for many years to come and not have a mortgage. However, it may be difficult to find a home that suits your needs that falls well under the exemption cap. Another possibility would be to explore various entities such as an irrevocable trust or a limited liability company to hold title to your home and/or to hold funds obtained through loans against your home (to keep equity below the homestead exemption cap). However, those possibilities involve trade-offs and are not suitable for most people.
What I have chosen to do is simple. I purchased an umbrella insurance policy. Umbrella insurance provides protection beyond existing limits and coverages of other policies. Umbrella insurance can provide coverage for injuries, property damage, certain lawsuits, and personal liability situations. As part of the process of applying for umbrella insurance, I had to review and upgrade my automobile and homeowners insurance to bring their limits up to the amounts required by the umbrella policy. The resulting increase to those premiums was negligible. Once that was complete, the carrier for the umbrella policy approved my application.
For less than $300 per year, our umbrella policy provides coverage of one million dollars per occurrence. This coverage, of course, is above and beyond the coverage that may be provided by other policies that we have. There should be ample insurance coverage in the event of a claim or lawsuit. Further, if we are sued for a covered cause of action, the umbrella insurance pays for our legal defense. Thus, our home equity likely wouldn’t become a target nor would other assets.
How about you? Does your state have a homestead exemption? What is your plan to protect your home equity?
With Love,
P. Gustav Mueller, author of The Present