Death is not the most cheery topic of discussion. And debt would likely rank as a close second for unsavory dinner conversation, though there are probably some that would label death as second to debt. However, they are two of life’s few certainties, along with taxes which makes them essential to discuss no matter the discomfort.
It can be challenging to pay off your debts while alive, but what happens to debt after you die? What debts are forgiven at death, and what debts still need to be paid after death?
Unfortunately, most of your debts do not disappear after death. But, in many cases, you don’t need to be overly concerned about your loved ones being saddled with debt left behind. The handling of finances after death is an exact legal process that seeks to tie everything up smoothly.
What Happens to Finances After Death?
After an individual passes away, everything they owned of monetary value is passed onto their estate. The deceased person’s estate l is the collective property, possessions, life insurance benefits, assets, and money owned by them in life.
All assets not stipulated in the Will of the deceased person will become the estate’s assets. Each state’s laws differ, so it’s important to become familiar with both federal and state laws on estates.
An Estate and Its Assets
Just as your assets pass to your estate, most of your debts will also be passed onto your estate. Your debts will not automatically be put on the shoulders of your family members unless they were joint account owners or co-signers.
The process of dividing up a deceased person’s debt is called probate. The probate process can be quite complex depending on what financial planning was done before death and how much outstanding debt has been left behind. Probate will deal with all creditors that come forward, from mortgages and credit card debt all the way to payday loans for bad credit.
During the probate process, creditors have a specific number of months to make a claim against your estate. When this happens, the beneficiaries of your estate handle the unpaid debts using the assets passed down to the estate.
Community Property State
Community property states have laws that dictate that any communal property shared by the deceased individual and their surviving spouse must be sold off to pay debts. In this case, the surviving spouse could be responsible for handling debts in a community property state if they wish to keep the communal property.
Community property states include Arizona, California, Idaho, Louisiana, Nevada, New Mexico, South Dakota, Tennessee, Texas, Washington, and Wisconsin. There are elective provisions for communal property in Alaska and Oklahoma.
What Debts Have the Possibility of Being Forgiven?
While a majority of debts are not forgiven after death, there are a couple of notable exceptions. Student loans are one of the few types of debt that are often forgiven at death. Not all student loan debt is forgiven, as there are some private student loan companies that will make claims against an estate instead of forgiving student loans.
Federal Student Loans
All federal student loans are typically forgiven upon the borrower’s death. A family member will apply for discharge which will apply to all direct federal loans. Additionally, if a parent has taken out a PLUS federal student loan on behalf of the student, that loan will be forgiven in the event of the death of the student or the parent.
Private Student Loans
Private student loans are not as consistently forgiven as federal loans. Some private student loan companies like Sallie Mae, Wells Fargo, and RISLA often consider Loan forgiveness in the event of a student’s death, but other private lenders do not.
As student loans are unsecured debt, if the estate cannot afford to pay any remaining debt, then the creditors will be forced to write it off as bad debt.
What Debts Can Be Inherited?
Most debts that are not forgiven at death will be handled by the estate through probate, with a few exceptions. All of this is mainly dependent on what safety nets were put into place by the deceased individual. Did they have a life insurance policy? Did they have retirement accounts or enough assets to cover debts?
Here is a brief overview of how different types of debt are handled in probate:
Joint Account Holders
If you have any loans or credit card debt with a joint owner, co-signer or co-borrower, they will be held responsible for the debt after your debt. Personal loans and credit card debt with a joint account holder will not become the estate’s debt. The joint account holder or co-signer will take on the remainder of the balance.
Credit Card Debt
Since credit card debt is a form of unsecured debt, the card owner is typically the only one who can be held responsible for the remaining balance. The credit card company will need to make a claim on the deceased individual’s estate. But if there is not enough money in the estate to pay off the credit card debt remaining, then all credit card companies who made a claim will have to write off the balances.
While the joint owners of a credit card will be responsible for the debt owed, an authorized user on a credit card has no ownership over the account. An authorized user will not be required to pay off the debt after the credit card owner has passed.
Car Loan Debt
Auto loans are secured debt, meaning that if the car payments are not made, the loan servicer could repossess the vehicle. The remaining debt on a car loan is paid out of the estate if the heirs so choose.
Those in control of the estate can choose to take on the car loan themselves to keep the vehicle, sell the vehicle to pay the balance, or let the lender repossess the vehicle if they don’t wish to keep it.
Mortgage Debt
Mortgages, like car loans, are secured loans set up against collateral. The collateral on a mortgage loan is the home you purchased with it. The estate will be used to pay creditors the remaining balance on the house, so it is not foreclosed on.
If you left the house to someone else and your estate cannot pay off the mortgage loan debt, the new owner will be responsible for the mortgage payments after your death.
Medical Debt
Medical bills tend to be the first debt handled by the estate in the probate process. Medical debt is paid out of the estate. Some of the smaller medical bills may just be closed out and declared uncollectible.
If you received Medicaid benefits after turning 55, it’s possible that your state may make a claim on your estate to get back some payments you received. If there is not enough money in the estate to handle all the medical debt remaining, the remaining balances may need to be written off.
Preparing Your Finances
There are plenty of ways to better prepare your finances to make your passing as smooth as it can be for your loved ones. Even though our own death is not something we want to spend much time thinking about, making proper preparations could give you peace of mind that the people you love the most will be taken care of and not have any added stress while grieving their loss.
Here are a few ways to prepare your finances to make things easier after your passing:
Life Insurance Policies
Everyone with a spouse and children, whether young or old, or any other loved ones who depend on them financially should have a life insurance policy.
Life insurance policies provide a death benefit to the policy holder’s beneficiary after they pass. This death benefit is money that can help the life insurance beneficiaries handle funeral expenses, long-term financial needs, and debts left behind.
A large life insurance payout can make all the difference when debt collectors come knocking on the doors of your family members. If you have not purchased a life insurance policy yet, doing so as soon as possible is one of the best things you can do to ensure that your family members have what they need.
Work With a Certified Financial Planner
Don’t be afraid to get the financial support you need from professionals. You can’t expect yourself to know everything there is to know about estate and financial planning. Admitting you need help will empower you to make all the right moves with an experienced estate planning attorney by your side.
Have a Frank Discussion With Your Family
It is essential to discuss all possible eventualities with your family members, even if the discussion is difficult or uncomfortable. Discuss how the estate will pay outstanding debts that may exist after your passing. Show your family the life insurance policy you have and what they can expect to receive. Clear communication about the possibilities that exist in the far-off or near future can relieve anxieties about what might happen after you pass.
References:
What Debts are Forgiven at Death? | Policy Advice
Debt After Death: What You Should Know | Kiplinger
What Happens to my Debt When I Die? Is it Forgiven or Transferable?
5 Reasons Why Life Insurance Is Important