It may not be pleasant to think about what will happen when you or someone close to you dies, but part of the reason we work and build our financial lives the way we do is because we want to take care of our loved ones after we’re gone. Knowing how debt works after death and being prepared with clear instructions for inheritors is one of the best ways to ensure that all your hard work pays off. Here’s how debt works when someone dies — and how to set things up for the people close to them.
Who Has to Pay the Debt?
When someone passes away, their estate — or cumulated assets — is generally responsible for paying any outstanding debts. It’s up to the executor of an estate (the person who has been deemed legally in charge of taking care of the estate after someone passes away) to see that debts are paid.
Most debts must be paid back, provided there is enough money in the estate. The types of debts that must be paid back include credit card debt, car loans, private student loans (federal student loans are discharged at death), home equity lines of credit, and mortgages.
If you owe money on a mortgage at the time of your death, things can get a little complicated. There are three common scenarios:
Your estate pays off the mortgage. If your heirs would like to keep your house, and there is enough money in your estate to finish paying the mortgage, they can choose to do so. If you’d like for this to happen, you should make it clear in your will in order to avoid confusion. In some cases, a life insurance policy can also be used to finish paying off the mortgage.
A surviving relative takes on the mortgage. If a surviving relative who is named in your will decides to take on ownership of your home, that person will take on the mortgage as well. (They will likely want to refinance, especially if this helps them get a lower rate or monthly payment.) The person who inherits the home always has the option to simply assume the deceased’s mortgage by notifying the lender, so if they can’t qualify for a mortgage on their own but can keep paying the original one, they can keep the home.
Your heirs sell it or walk away. If your heirs can’t afford the mortgage and your estate can’t or won’t pay it off, then they can choose to either sell the home or, if it’s underwater (worth less than is owed on the mortgage), walk away. This means leaving the house for the bank to foreclose on it.
In some cases, such as if you took out a reverse mortgage or left a lot of debt behind (and live in a state where homes qualify as an asset that can be used to pay off those debts), your heirs may not have much of a choice as to what to do with the home. Creditors may have a right to seize the property to pay the outstanding debts.
What if the Estate Is Broke?
Usually, if there are not enough assets or money in the estate to pay back debts after someone passes away, those debts will be erased. Creditors will write them off as long as there aren’t cosigners in the case of loans or credit card debt. However, beware that some creditors can be unscrupulous and will hire collection agencies to harass surviving family members about paying debts — even if they didn’t cosign. This type of harassment is not legal, but it still happens. Do your research and know your rights, and if collectors continue to hound you for debts you are not liable for, then consult a lawyer.
When Family Members Must Pay
Surviving family members are responsible for the deceased’s debts if they are cosigners on credit cards, loans, or mortgages. (When it comes to credit cards, an “authorized user” is not responsible for paying debts after the death of the account holder. However, if the debts are not settled, an authorized user’s credit score could be hurt. In that case, simply contact the lender and request to be removed. This account will then drop from your credit report altogether.)
Another wrench in the situation comes in the form of state-by-state laws. Some states are considered “community property states,” which means that any property owned by one spouse is also owned by the other. Similarly, any debt owed by one spouse may also be owed by the other, including in the case of death, depending on what state you live in. There is not a uniform set of regulations, so if you live in a community property state, you should consult a lawyer.
What Surviving Relatives Need to Know
It’s important that you ask someone to be the executor prior to your passing (usually when you create your will with an estate attorney) and make sure the person understands the obligation. It can be a serious undertaking to untangle the estate and tax laws that come along with it.
You also have the option to forgo naming a family member or friend as your executor and stick with the pros. Lawyers, accountants, or a trust company are all possible choices. Additionally, you should keep your will up-to-date and be clear about your wishes. If you do have debts, it’s a good idea to talk to a lawyer about how they will be handled when you pass away, and to communicate this information to your loved ones so there are no surprises.
Before joining the Society of Grownups, Karen Carr completed a BS in finance, obtained her CFP®, and went on to work as an advisor at a boutique, private wealth management firm.