Consider the following buyer, Frank, in your sphere of influence. He saved his nest egg over a successful 25 year career. Frank accepted a buyout from his employer in another state and took early retirement to begin his encore career, starting a new small business in Colorado. He funded his venture with his own savings, the proceeds of his buyout and by borrowing $200,000 from the Bank. Since he was new to Colorado, Frank did not immediately buy a home upon arriving here, and is instead renting a house.
Unfortunately, Frank’s business is failing. It has yet to produce a profitable quarter, start up losses were above projections, and losses have begun to grow. Frank has drawn his saving down to $80,000. Unless things turn around quickly, Frank will shut the business down, leaving him liable for the $200,000 debt with only $80,000 to pay it back. Is there anything Frank can do to legally shelter his last $80,000 from the reach of the Bank? The Colorado legislature, and the law makers of almost every state, has decided that there are certain assets that should be beyond the reach of creditors (unless the borrower voluntarily pledges such an “exempt” asset as collateral). Colorado’s homestead exemption allows a debtor to shelter $60,000 of net equity in his or her home. (CO ST § 38-41-201(1)(a)). If the debtor is 60 or over, the homestead exemption shelters $90,000 of net equity. (CO ST § 38-41-201(1)(b), 2(b)). The amount sheltered is the value of the home, after deducting the mortgage debt and the reasonable costs of sale (CO ST § 38-41-206(4)).
Frank can essentially shelter his $80,000 of cash from the reach of his creditors by using his $80,000 as a down payment to buy a home for him to live in. So, for example, you might help Frank find a property owned by sellers who are willing to carry the $220,000 of financing. (Frank might have a hard time getting more conventional financing because of the decline of his business.)
Post closing, Frank has $80,000 of “gross” equity in his home. If, however, a judgment lien creditor foreclosed on his home and re-sold it, that creditor would have costs of sale of approximately $20,000 so, in the terminology of this article, Frank has $60,000 of net equity in his home. As a consequence, Frank’s home could not initially be taken by the Bank if the Bank sued Frank for his losses.
The nuances of taking full advantage of the homestead exemption cannot be fully vetted in this article. Frank hopes that his home will appreciate, in which case he’ll have more than $60,000 of net equity. By amortizing his debt, he would also hope to build his equity above the homestead exemption. If Frank were to file bankruptcy shortly after buying his home, some creditors would argue that he has abused the homestead exemption. Borrowers facing financial disaster shouldn’t put their last nickel into a home without first consulting a lawyer, yet one of the counterintuitive things about our current economy is that with a little education, some consumers facing financial disaster should be motivated buyers.
