Purpose
The Equity Protection Mortgage is a program whereby clients can reduce or eliminate the amount of equity in their home (or other property) with the following advantages:
- Asset protection
- Tax savings
- Creation of a vehicle for tax-free offshore investing
- Estate planning
- Increased cashflow.
Overview
Home ownership has traditionally been an integral part of the American dream. However, there are significant costs associated with equity ownership in a home. These include exposure to creditors, higher taxes and lost investment opportunities. The Equity Protection Mortgage® allows an individual to enjoy the benefits of home ownership (or other real property) while avoiding these problems.
Reducing the equity in a property (sometimes referred to as “equity-stripping”) is one of the best ways to protect an asset and reduce exposure to creditors. The concept behind equity-stripping is simple; if an individual does not own any interest in the property, there is nothing for a creditor to get. Therefore a creditor will not attempt to execute on the property. As with most asset protection techniques, equity stripping works best when it is done before a creditor attack.
By having less equity in a home and carrying a higher loan balance, a client is also able to take advantage of a higher mortgage interest deduction, thus reducing his tax burden.
Finally, the Equity Protection Mortgage offers the opportunity to take advantage of investment opportunities through offshore investing. Under this program, a client takes out a mortgage on a home or other real property, which is serviced by a third party mortgage company but funded by an offshore affiliate that is ultimately controlled by the client.* Payments on the mortgage are made to that affiliate and are invested offshore in a tax-free environment.
The Equity Protection Mortgage is offered exclusively through Merrill Scott & Associates.
How it Works
First, a client applies to MSA Mortgage Services for an Equity Protection Mortgage. After the standard application and underwriting process, MSA Mortgage Services approves and originates the mortgage which is funded through Legacy Funding, a subsidiary of Legacy Mortgages, a UK company. Once Legacy issues the mortgage, it enters into a sub-service agreement with a “decontrolled” offshore International Business Corporation (“IBC”) of the client.* Under the sub-service agreement, the IBC advances a sum equal to the amount of the mortgage to Legacy in return for rights to the principal and the interest stream from the mortgage at an agreed upon interest rate.
The client then begins to make payments on the mortgage pursuant to the particular payment option plan selected (see “Payment Options” below). These payments are made to Legacy Servicing, another wholly owned subsidiary of Legacy Mortgages. The payments to the IBC represent the agreed-upon interest rate and principal (if any). This money may be invested offshore free of U.S. taxation.
In this way, the client has protected his home from creditors by reducing the equity in it while also taking advantage of the mortgage interest deduction and channeling money offshore to be invested tax free.
Asset Protection
There are two general objectives behind asset protection strategies. One is, through legal structures or relationships, to place assets beyond the reach of creditors. Another is to position those assets so as to deter creditors from pursuing those assets or to hinder their ability to successfully pursue them.
The Equity Protection Mortgage effectively accomplishes both of these goals. With no equity in a home (or other real property), there is nothing for a creditor to attack. Furthermore, an Equity Protection Mortgage® deters creditor inquiry as it is structured as an arm’s length transaction with a neutral third party. Other asset protection strategies, such as the transfer of assets to family members, cross-collateralization of properties or the creation of legal entities without economic substance are more transparent and vulnerable to attack.
Other viable asset protection strategies include the creation, annuities, trusts (domestic and offshore), corporate entities with economic substance, family limited partnerships, etc. Like these, the Equity Protection Mortgage provides solid asset protection while offering additional financial benefits.
As with any mortgage, an Equity Protection Mortgage will be subject to fraudulent transfer laws. In general terms, these laws may cause a mortgage to be set aside if the mortgage renders a debtor insolvent or is made with the intent to delay, hinder or defraud creditors and the mortgage lender had notice of the pending claim or judgment, or if the lien against the property was not properly filed.
Tax Savings
Generally, 100% of interest payments are deductible (up to the limit of $500,000). By taking full advantage of this deduction and maintaining a mortgage of at least $500,000 on a home will enable the client to maximize the availability of the deduction and thus reduce the required net income.
Offshore Investing
Through the Equity Protection Mortgage a client can invest money offshore that would otherwise be paid in taxes to the IRS.
For example, assume that a client has a $500,000 mortgage with a 10% interest rate. (Because of the home mortgage deduction, his net cost to borrow is only 5%). Payment on this 10% note goes to Legacy Services, the mortgage servicing company. After retaining a 2% servicing fee, Legacy forwards the remaining 8% to the client’s “decontrolled” IBC where it can be invested tax-free. Thus, 3% of the 8% payment going to the IBC would have otherwise been paid to the IRS in taxes (8%-5%). Therefore, even though a client carries a higher loan balance and pays mortgage service fees, his net may be higher than without the mortgage.
The Equity Protection Mortgage can also be used as a vehicle to invest larger sums offshore tax free through prepayment of the mortgage as described below.
Estate Planning
A mortgage on a property reduces the value of a decedent’s estate to the extent of that mortgage. An Equity Protection Mortgage is an especially powerful estate planning tool since, although a mortgaged home will not be part of the decedent’s estate, the money equal to the value of the home remains in an IBC offshore that is within the ultimate control of the decedent. To access those funds, the heirs can access the IBC, “unwind” the mortgage (see below) or otherwise repatriate the capital.
Increase Cash Flow
As with other mortgages, the Equity Protection Mortgage can enhance cash flow. This can be done through home equity lines or through repatriation directly from the IBC. The proceeds can be used for personal or business needs.
Pricing the Mortgage
While low interest rates are generally desirable for mortgages, a higher interest rate may be preferred on an Equity Protection Mortgage. This is because the money paid towards the mortgage is ultimately deposited with the IBC offshore where it can be invested tax-free. Thus, with a higher interest rate, the client avails himself of the home mortgage interest deduction while making larger payments to be invested offshore.
Some of the relevant considerations in determining the optimum interest rate on the mortgage include: 1) what percentage of the value of the home is eligible for the mortgage interest deduction; 2) domestic cash flow needs of the client; and 3) the interest rate of any existing mortgage on the property and the resultant “blended” rate of the two.
Payment Options
A client has four payment options with an Equity Protection Mortgage. Because of its unique features, a client may find a payment option preferable under this program that would otherwise be uneconomical or unavailable.
Thirty Year Amortization
This payment option mirrors the typical repayment terms of conventional mortgages. However, whereas the Equity Protection Mortgage is designed to minimize the equity available to creditors, as well as to increase a client’s overseas investments, a 30 year amortization may not be a preferred payment plan. If the sole objective of the mortgage is asset protection, then this option would likely not be desirable. However, if offshore investing is an objective, then this plan may be desirable as offshore investments can increase at a moderate rate through the payment of principal and interest.
Negative Amortization
A negative amortization plan is where the outstanding balance may increase over time, to the extent that payments fall short of the accrued interest rate on the note. For example, with the Equity Protection Mortgage a client may pay as little as 2% against a 10% note rate. In such a scenario, the 8% differential would increase the principal balance of the mortgage to the extent of that differential.
There are at least three instances when a client would prefer this option.
1) The client desires to improve cash flow through a reduced monthly mortgage payment.
2) The client desires to “index” his mortgage obligation with the long-term rise in property value. This would be particularly important in a “hot market” where asset protection is a principal objective.
3) Money that would be used to make the mortgage payment is invested (offshore or otherwise) earning a higher net yield than the cost of the mortgage.
If the client is no longer able to afford the mortgage payments, or needs an increase in cash flow there are other ways to accomplish this such as by “unwinding” the mortgage or taking out a personal loan from an affiliated entity as described below.
Interest Only Payments
Under this option, the client pays interest only on the mortgage, thereby never acquiring equity in the property. From an asset protection stand point, this option may be the preferred payment option. However, if one purpose of the mortgage is to make offshore investments, the client should be aware that only interest payments are available for offshore investing. (As stated above, the amount available for offshore investing will typically be the value of the interest rate less two points).
Irregular Extra Principal Payments
Under this option, a client makes unscheduled payments to pre-pay the mortgage. Under this option, a client will more quickly accumulate equity in the property while investing more money offshore and at a faster rate. Thus, from an asset protection perspective, the client may be marginally more vulnerable than with the other payment options. From an investment standpoint, however, the client is investing more money offshore tax free.
The option may be more attractive given that subsequent mortgages to reduce the accumulating equity are possible.
Risks of Foreclosure and “Unwinding” the Mortgage
Practically speaking, foreclosure is not a risk with the Equity Protection Mortgage®. In the event that the client could no longer afford the mortgage payments, he would simply cause the mortgage to be “unwound”. This would be done by requiring Legacy Mortgages to pay off the outstanding balance of the loan according to the terms of the sub-service agreement.
Alternatively, the client could pay off the balance of the mortgage with sums invested offshore with affiliated IBCs or other structures.
Repatriation
Once money paid towards the mortgage is offshore, it can be repatriated in several ways. These can be through personal loans, salaries or consulting fees from the IBC, a secured credit card (for business expenses only), or even through another mortgage. (For a complete review of the various repatriation techniques, see the MSA brochure “Repatriation of Offshore Assets”).
Synergistic Structuring
The Equity Protection Mortgage can be structured in the context of other existing mortgages or in conjunction with a restructure or transfer of ownership.
Opportunities to leverage a first mortgage with the Equity Protection Mortgage will be considered, as it may be desirable to pay-off or re-finance an existing mortgage in order to make more money available for offshore investing or to improve monthly cashflow. For example, a client may desire to pay off a first mortgage and obtain a 100% loan to value mortgage through an Equity Protection Mortgage as a conduit to taking excess cash offshore. Or, a client may choose to re-finance an existing mortgage in order to take advantage of better current interest rates.
In addition, the Equity Protection Mortgage can be issued in conjunction with a transfer of ownership (e.g. from personal ownership to corporate or partnership ownership, etc.).