Conversion of Secured Debt into Unsecured Debt

April 13, 2006

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Consensual liens, such as mortgages and car loans, generally cannot be eliminated even when they impair an exemption. When executing a comprehensive asset exemption plan, another effective strategy consists of paying down secured debt with unsecured debt. This can be especially effective prior to a bankruptcy action (if planned far enough in advance).

For example, you could make a mortgage payment with a credit card. The amount of cash represented by the payment is effectively converted to an exempt form (equity in your home, which is presumably protected by the homestead exemption). Because the unsecured credit card debt can be discharged in bankruptcy, the debtor protects this amount of cash as if it were an exempt asset.

John Smith, a Texas resident, is carrying a $160,000 mortgage on a home worth $180,000. Smith's monthly mortgage payment is $1,600.

Smith is short of funds, and anticipates, sometime in the future, that he may have to file for bankruptcy.

He makes two mortgage payments using his credit card's "access checks," for a total of $3,200, and files for bankruptcy 14 months later.

Smith has converted the $3,200 to an exempt form. The credit card debt, including the $3,200, will likely be discharged. In short, Smith has protected and saved $3,200.