Most debt does not go away when you die. Who becomes responsible for it depends on your state and what type of debt it is.
In this article, you’ll learn what happens to debt when you die and how life insurance can protect your loved ones from inheriting this debt.
Debt will typically fall into one of two categories: secured or unsecured.
- Secured debt: requires an asset as collateral. If you default on payment, the lender can seize the asset to recoup costs. Examples include mortgage and auto loans.
- Unsecured debt: doesn’t require collateral and is based on the borrower’s creditworthiness. If you can’t make payments, interest and fees accumulate. The lender may eventually turn it over to a debt collector who will make numerous attempts to collect payment from you. Examples include credit card debt and medical bills.
If you have debt, whether secured or unsecured, when you die, it typically becomes the responsibility of your estate. But that doesn’t mean your loved ones are completely off the hook.
An estate consists of everything you own. This can include cash, property, investments, and other assets.
When you die, your estate goes through a process called probate, which means:
- Your estate is valued, and any liabilities are subtracted from your estate’s worth, including debt.
- Based on state law, the probate court determines who becomes responsible for the estate’s debt.
- Probate court approves an estate executor to pay bills and distribute assets to heirs.
Typically, this is how state law passes down debt:
- Any co-signed debt, such as private student loans, becomes the responsibility of the surviving cosigner.
- Any jointly-owned debt, such as two spouses owning a house, becomes the responsibility of the surviving owner.
- Debt acquired while married in a community-property state becomes the responsibility of the surviving spouse.
- Debt owned solely by the deceased will be paid using assets from the estate.
Common Types of Debt and How They’re Passed On
Year over year, average consumer debt in America increases. When we take on this debt, we don’t have our death in mind. But you never know what may happen tomorrow.
If you died unexpectedly, do you know what happens to the debt you currently owe?
Debt in a Community-Property State
If you’re married and living in a community-property state (AZ, CA, ID, LA, NV, NM, TX, WA, WI), any debt you acquire during marriage becomes your spouse’s responsibility when you die, even unsecured loans.
Some community-property states allow you to formally divide property with a Separate Property Agreement so creditors can’t come after the surviving spouse for payment. This is usually done in writing.
Student Loans
Only one type of debt is discharged upon your death: federal student loans. Once proof of death is submitted, the debt is erased.
Changes in tax law have also eliminated taxes on discharged student loan debt. Previously, any student loan debt canceled due to death or disability was taxable.
Private student loans are usually not forgiven. These loans often require a co-signer. That person becomes responsible for paying back the loan if you die.
Mortgage Loan
A mortgage loan does not get discharged on death. Five things typically can occur:
- Your estate has enough funds to pay off the loan, and your house is transferred to your heirs free and clear.
- If you own mortgage protection insurance, your home will be paid off when you die. (We advocate for life insurance instead.)
- Your heirs take on your loan and continue paying the same premiums.
- Your heirs sell the home (or walk away from it, causing foreclosure). If the home is sold for less than what is owed, creditors can still sue the estate to recoup its losses.
- You have substantial debt, and the state requires the home to be sold to pay your bills.
Home Equity Loan
What happens with a home equity loan is similar to a mortgage loan. When you die, one of three things happen to the loan:
- It will be paid from assets in your estate
- Your heirs can take over the loan
- The home will be sold to pay off the loan
Car Loan
If this loan is cosigned, that person is responsible for the loan. If there is no co-signer, heirs have some options.
- They can take over the payments and keep the vehicle.
- They can sell the car and pay off the loan.
- They can often return the car to the dealer. The dealer typically sells it at auction and applies the proceeds to the loan. If there is still money owed, the dealer will bill the estate.
Credit Card Debt
Credit card companies will attempt to get paid from your estate when you die. If no money is left in your estate to pay off the debt, the credit card companies won’t get paid.
If the credit card is cosigned, the co-signer must pay the balance. Authorized credit card users aren’t responsible for the balance, but they can no longer use the card.
Personal Loan
Personal loans can be used for various expenses. Some common uses of them are:
- Debt consolidation
- Home renovation
- Funding weddings
- Funding vacations
Lenders often pitch buying credit insurance when you take out a personal loan. (It may also be offered with credit cards and auto or home loans.)
Credit insurance pays back the lender if you can’t. If you were to die and you have credit insurance, the lender gets paid. If you die without credit insurance—you guessed it—the lender will make a claim on your estate.
Again, we advocate for term insurance over credit insurance. Term insurance can be more cost-effective than credit insurance and is more beneficial to your loved ones.
