The following is an excerpt from my book Margin Matters: How to Live on a Simple Budget & Crush Debt Forever.
Have you ever wondered what happens to someone’s debt after they die? I know I have. It seems like people are living their lives as if their debt is going to magically disappear once they’re gone. Unfortunately, this is not the case as the average person will die with $63,000 of debt. According to NerdWallet, your debts become the responsibility of your estate after you die. Your estate is everything you owned at the time of your death.
Here’s how it works:
The executor of your estate, the person responsible for dealing with your will and estate after your death, will use your assets to pay off your debts. This could mean writing checks from a bank account or selling property to get the money. In some cases, family members could even be on the hook for your debt. Many people buy life insurance not only to leave financial security behind for their loved ones, but also to help deal with any debt and final expenses.
- estate — all the money and property owned by a person, especially at death.
- executor — a person or institution appointed by a testator (person who made the will) to carry out the terms of their will.
- probate — the legal process by which a decedent’s will is processed by a special court.
The process of paying your bills and distributing what’s left is called probate. Your appointed executor will use your assets to pay off your debts. Writing checks from a bank account or selling property to obtain the funding are common occurrences in this process. If there isn’t enough to cover your debts, creditors are usually out of luck. However, specific types of debts can become other people’s burden.
The following could be someone else’s headache after you die:
- Mortgage – (Will debt need repaid?) Yes, if there’s a joint homeowner or if someone inherits the house. Federal law bars lenders from forcing a joint owner to pay off the mortgage immediately after the death of another co-owner. If there’s no joint homeowner, the executor can pay the mortgage out of the estate. If there’s not enough money in the estate, a family member who inherits the house can simply take over the mortgage payments.
- Home equity loan – (Will debt need repaid?) Yes, if someone inherits the house. A lender can force someone who inherits a home to repay the home equity loan immediately, which could require selling the house. However, lenders might work with new owners to let them simply take over the payments on the home equity loan.
- Credit cards – (Will debt need repaid?) Maybe. If the estate runs out of assets to pay credit card balances, credit card companies are out of luck because this debt is not secured by assets the way mortgages and car loans are. Any joint account holder would be responsible for the unpaid bills. People who are simply authorized users of a credit card are not responsible for paying the balance. In community property states, spouses are responsible for any debts incurred during the marriage, including credit card debt.
- Car loan – (Will debt need repaid?) Maybe. The executor can pay the car loan out of the estate. If payments stop, the lender can repossess the car. If the estate can’t pay off the car loan, whoever inherits the vehicle can simply continue making payments and the lender is unlikely to take action.
- Student loans – (Will debt need repaid?) Maybe. The estate should pay off private student loan debt, but lenders have no recourse if the estate doesn’t have assets to repay unsecured obligations such as student loans. Co-signers of private student loans will be responsible for remaining debt, and in community property states, the spouse will be responsible if the student loan debt was incurred during the marriage. Some lenders of private student loans will forgive the debt upon death, including Sallie Mae and Wells Fargo. Federal student loans are discharged upon your death. If a student’s parent has a federal PLUS loan, it will be discharged upon the death of either the parent or student.
What Creditors Can’t Take
In most cases, creditors can’t go after your retirement accounts or life insurance benefits. Those will go to the named beneficiaries and aren’t part of the probate process that settles your estate. Life insurance payouts are also protected from creditors. As a result, you can use a policy to protect family members who would be responsible for your debts or simply to make sure you have money to pass on. Additionally, life insurance payouts are usually not taxable.
Term life insurance policies, which provide a death benefit for a set number of years, are suitable for most people’s needs and cost less than permanent life insurance. Also of note: If the life insurance beneficiaries you named are no longer living, your death benefit may go into your estate and be subject to creditors. That’s why it’s important to keep your beneficiary info updated.
Final Thoughts: Leaving Your Legacy
Knowing all this—what would you rather do: Leave assets to your heirs or a pile of debt for them to clean up?