What Happens to your Debt when you Die?

June 9, 2018

Upon an individual’s death, they leave substantial amounts of debt. Sometimes, your debt obligation may end upon your death. Beware though that if you didn’t plan accordingly, creditors may wipe out your accumulated investments, assets, or savings. As a result, your dependents are left with nothing. What’s even worse they might be held accountable for your debt. However, this depends on factors such as where you live, the debt amount owed, its type, and your estate’s value at the time of your death.

Typically, all debts you owe are levied against your estate. If you have sufficient assets to pay off the debt, your estate executor has the responsibility of paying off this debt. Doing so may involve the selling of any personal properties or family heirlooms that bear your name. On the other hand, it becomes tricky to pay off any debts you have if your estate doesn’t have enough. Debts that are secured like home and auto loans fall in the precinct of your inheritors. Conversely, any unsecured debts owed by you such as student loans and credit card balances will be paid by your estate. Most likely, you inheritors won’t be held liable for any outstanding debts or balances. Here are a few exceptions to this rule.

Communal Property States

Thanks to community property laws in these nine states: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin all debts accumulated by married couples equally belong to both parties. As a result, creditors can collect any debts you owe from your spouse.

However, creditors are forbidden from collecting any debts you incurred before getting married. Likewise, they can’t do so on the property you acquire together but keep separate. For instance, they can’t go after any autos that you finance even when such a car was purchased after your marriage. Given that, it’s important filing requisite paperwork so as not to saddle your spouse with debt.

Similarly, this rule applies if you have cosigned a credit card for a relative or friend. Any authorized user of that credit card won’t be held responsible for any debt. However, they must surrender the card immediately after your demise, to avoid identity theft charges.

Home Equity Loans

Similar to all secured debts, home equity loans are the responsibility of your estate, your cosigner, or your inheritor. But there is a difference between regular mortgages and home equity loans if a borrower dies: creditors have the option of demanding for full settlement of a debt upon your death. Otherwise, they can repossess your home. However, it’s perfectly acceptable for your inheritor to make an agreement for the paying debts in installments, though this depends on the lending policy or creditworthiness.

Private Student Loans

All federal student loans you owe are forgiven upon your death. Nonetheless, companies that give student loans may not do so. Moreover, this debt typically falls on your estate. For instance, companies like Sallie Mae and Wells Fargo forgive debts after your death, so consider taking a private student loan from them.

Ensuring Your Heirs Benefit from Your Estate

Here are a few precautions to take to minimize the amount of debt you leave to your heirs.

To begin with, quantify the amount of debt you hold. Try reducing the amount of debt you accumulate too minimize the amount paid by your estate. Already in debt? Create a plan to pay it off while you are still alive. Accordingly, you should prioritize debts that a cosigner or spouse will probably be left with.

Second, review or create a will. Doing so prevents the state from stepping in and creating one for you. In case this happens, there are hefty legal and administrative fees which have to be paid before an estate is divided. By writing your own will, you protect your heirs from paying off these fees.

And finally, make retirement investments and obtain life insurance. As long as you have an appointed beneficiary to survive you, creditors can’t touch any of your retirement plans like 402(k) or IRAs. Only the federal government can do so. Any debts you owe the federal government is subject to taxation or penalties. But if you don’t hold any government debt, all your savings will pass to your heirs. What’s more, all creditors including the federal government can’t access any life insurance policies you own. Remember that your heirs can use these funds to settle any debts that you owe.