What Happens to Your Debt When You Die, and Why Does it Matter?
They say you can’t take it with you, but taking care of your debts before you die can make a big difference for your loved ones.
July 26, 2022
This article is provided for informational purposes only and should not be construed as legal or investment advice. Consult with a professional financial or investment advisor before making investment decisions.
Most people don’t like to think about morbid things, like what happens when they die. But like it or not, understanding how your debts can affect your family members after your passing is an important thing to consider when planning for the future. While you may no longer be around to worry about debt collectors or your credit score, a person’s debt can continue to affect their loved ones after their passing.
By understanding what happens to your debt when you die, you can plan for the future so that your family’s financial situation is secure. In this article, we’ll cover what happens to different types of debt after you die (including shared debt) as well as how you can pay off your debts and protect your family through life insurance.
What happens to your debt when you die?
After a person dies, the deceased person’s estate is responsible for covering their outstanding debts. Assets will likely be moved to probate and distributed in a manner to pay off creditors. Creditors can seize a wide variety of assets to pay off your debts, including vehicles, real estate, jewelry, antiques and even family heirlooms.
Debt forgiveness is rare when someone dies, though federal student loan balances are forgiven when the borrower passes away. As such, understanding how your debts are managed is crucial.
There are two main types of debt to be aware of: secured debt and unsecured debt.
Secured debts describe loans that are ”secured,” or tied to a specific asset, which serves as collateral for the loan. For example, auto loans are “secured” by the car that you took out a loan to purchase. A home equity loan or a mortgage is secured by the property.
With these types of debt, your estate will typically be required to pay off the remaining balance after you die unless you cosigned the loan with someone else. If you left the car or house to a friend or family member, they will then assume responsibility for any remaining monthly payments for the balance that your estate couldn’t cover. If they don’t want to (or can’t) take on these payments, the creditor can reclaim the property.
Housing debt is a little different for married couples in community property states, which include Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin. In these states, the surviving spouse becomes fully responsible for mortgage debt, regardless of if their name is on the original loan. Alaska, South Dakota, and Tennessee also have “opt-in” community property laws.
Unsecured debt is not tied to a specific asset. These debts include personal loans and credit card debt as well as student loans and medical debt.
For unsecured debts, creditors can claim money and property from your estate to cover the outstanding amount. While the way medical bills are handled varies based on state law, this is often the first type of debt to be claimed. Credit card companies and other lenders can then receive assets from your estate to cover their loans.
If there is not enough money from your estate to fully cover a debt, the lender is out of luck. They will claim the full value of your remaining estate assets and then discharge the rest of the debt. They cannot go after your family members to secure repayment. However, this also means that there is nothing left from the estate to pass on to your surviving family members.
What about shared debts?
If you have a cosigner or joint account holder on any of your loans, the process for discharging your unpaid debts is a bit different. Cosigners and joint account holders are viewed as equally responsible for the debt. This means that the other individual on the account is expected to continue making payments as before.
While this may seem easier, it could put significant hardship on that person’s personal finances. For example, if your spouse was a joint account holder on your credit card but earned less money than you, they may not earn enough money on their own to keep up with debt payments. The same is true if they were a cosigner on a mortgage or car loan.
Keep in mind that authorized users on a credit card account are not the same as a joint account owner. Being an authorized user simply means an individual can use the card to make purchases. So, if your children were authorized users, they wouldn’t be responsible for your debt. However, if you and your spouse were joint account holders, the surviving spouse would still be responsible for paying off any debt on the card.
Using life insurance to protect your beneficiaries
Regardless of your debts, few parts of the estate planning process are more important than obtaining life insurance for your beneficiaries. Life insurance and some retirement accounts cannot be taken by creditors to pay your debts.
A life insurance policy can provide a significant payout to your beneficiaries after you die. This money can be used as they need. For example, the money could be used by your surviving spouse to pay off the outstanding balance on a mortgage or a car loan so that they don’t lose these important assets.
Shopping around with different insurance companies can give you a good idea of what options are available based on your age, health and the amount of money you wish to be insured for.
How to not leave behind unpaid debts
While your family members may not be directly responsible for paying off your remaining debts after you pass away, your ability to leave them some type of financial benefit will suffer if your estate’s assets need to be used to pay off debts. Outstanding debts could mean that your dream of passing on a home — or even money from your bank account — won’t be possible because of what you owe your lenders.
Because of this, you should take action to reduce your debt as early in life as you can.
Two popular methods for paying off debt are the debt avalanche and debt snowball methods. With the debt avalanche method, you make the minimum payment on all debts and put extra money toward the account with the highest interest rate. After the high-interest account is paid off, you shift extra payments to the debt with the next-highest rate until all debts have been paid off.
The debt snowball method takes a similar approach, but instead has you put the extra cash toward the debt with the smallest total amount. In this method, the goal is to quickly reduce the number of debt accounts you hold.
Protect your loved ones: Know what happens to your debt when you die
By understanding how unpaid debts can affect your estate after death, you can start planning now so that your family won’t be left in bad financial shape if you were to pass away unexpectedly.
It may be good to seek legal or financial assistance to better understand what happens to your debt when you die, based on local laws and your specific financial situation. Professional aid can help you make a plan for obtaining appropriate life insurance coverage and taking other steps to ensure that your estate and family are protected.
One way to ensure you don‘t leave behind any outstanding debt is to refinance debt to a lower interest rate or consolidate multiple accounts into a single line of credit. You can do this with credit card debt through the Tally† app, which lets you combine multiple credit card debts into a single monthly payment to help you pay off debt more quickly. By eliminating debts now, you can have confidence in the future.
†To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. The APR (which is the same as your interest rate) will be between 7.90% and 29.99% per year and will be based on your credit history. The APR will vary with the market based on the Prime Rate. Annual fees range from $0 - $300.