What is convertible debt?

Convertible debt is a financing term used to refer to any type of debt financing where there is an option to convert the outstanding balance due to some other form of security or asset. The term is used in reference to mortgages and other types of debt, as well as various forms of bonds.

As far as the mortgage is concerned, convertible debt would be any type of arrangement that allows converting the outstanding balance into equity. This factor can be very helpful in case the borrower fails to meet the payment terms associated with the mortgage. The mortgage holder may choose to convert the debt into equity and thus be able to recover from the loss created by the default.

In terms of other types of bonds, such as corporate collateral, convertible debt is sometimes used to refer to the ability to exchange one type of collateral issued by the corporation for a different type of collateral. For example, an outstanding bond issue that has terms and conditions that allow the bond to be converted into common stock would be considered an example of convertible debt. While this option does not necessarily need to be exercised, the terms generally define how the conversion would take place and at what price each share would be issued.

Convertible debt is sometimes referred to as one of several hybrid investment models in common use today. This option is often a mechanism that provides the debt holder with some additional security and options on how to proceed if the debt is at risk in some way, such as a default situation. The decision to structure a security as a convertible can be made for a variety of reasons, including projections to some future event that would make the conversion more advantageous for all parties involved. However, any investor should be advised to consider the terms and conditions associated with the specific transaction before entering into any contract involving convertible debt.