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It's quite common to die with debt in your name. When you die, most of your debts are collected from the value of your estate (everything you owned at the time of your death). In some cases, if you took out a joint mortgage with your spouse or live in a community property state, for instance, others may be responsible for your debts.
How Debt Is Handled After Death
Probate is the legal process for distributing your property after you die. During probate, a special court will validate your will and authorize someone to distribute your estate to your beneficiaries as you requested. They will also ask them to pay any taxes your estate may owe.
In the event you do not have a will, a court proceeding will be held to determine how to divide your estate. The court will name an administrator for your estate who will be required to follow the judge's directions on how to distribute your property.
Since probate laws differ from state to state, it's important to familiarize yourself with the legalities of probate where you live. This will help ensure that your final wishes are properly carried out.
Who Is Responsible for Debts of a Deceased Relative?
After you die, your debts will be classified as secured and unsecured. Secured loans such as mortgages and auto loans are backed by collateral—assets that can be taken by the lender if they don't get repaid. Most credit cards, student loans and other unsecured loans lack collateral.
Depending on the assets of your estate and the provisions you make before you die, your estate could entirely pay off your secured debts or make installment payments through a trust or other legal entity. Also, your property may be sold, refinanced or turned over to the lender to take care of the debt.
Any unsecured debts that belong to you will likely need to be paid from your estate. If you die with $10,000 in your savings account and $5,000 in student loan debt, for example, the lender would usually be paid before the remaining $5,000 can be distributed to your heirs.
If there are multiple creditors with total claims greater than the amount held by your estate, the laws in your state will determine who gets paid and how much. Your unsecured debts will go unpaid if your estate lacks sufficient funds to cover them.
Which Debt Can Be Inherited?
If you leave a will behind, the person appointed to distribute your estate (the executor) will collaborate with your creditors and survivors to settle any outstanding debts you may have. A probate court will handle this if there is no will.
To determine what debts you owe, the executor or probate officer will likely access your credit report and take a look at your open credit accounts. Then, they'll figure out which debts are inherited and must be paid off. Inherited debts may include:
- Joint debts: The most common example of a joint debt is a mortgage. If you took out a mortgage with your spouse, they'll be on the hook for paying it off if you die. Car loans, credit cards, lines of credit and almost any type of debt can be joint debts.
- Cosigned debt: A cosigner agrees to pay your debt in the event you default on a loan. If you had someone cosign any of your loans, they'll be responsible for the debt if you die. For example, if you had a credit card that only you used but your parent cosigned years ago when you were young, they'll be required to cover it.
- Home equity loan on an inherited house: A home equity loan can allow you to borrow money against the value of your home minus the amount of your outstanding mortgage. The home equity loan on an inherited house becomes an inherited debt upon your death.
- Debt in community property states: There are nine community property states: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin. If you live in a community property state or Alaska, which gives both parties the option to make their property community, your spouse may be liable for certain types of debt even if the loans were solely issued to you.
- Timeshares: If you purchased a timeshare and put the names of your heirs' on the deed to make it more convenient for them to use the property upon your death, your children will inherit the timeshare and be forced to pay the annual maintenance fees that come with it.
Which Assets Are Protected From Creditors?
There are certain assets that creditors can't go after once you die, such as:
- Retirement accounts: These may include an employer-sponsored 401(k) or 403(b) plan, Solo 401(k), SEP IRA, Simple IRA, Roth IRA or a health savings account you may have to fund your retirement.
- Life insurance: Life insurance is a contract you sign with an insurer so your beneficiaries are paid a lump-sum payment or death benefit when you die, as long as you make premium payments.
- Living trust: With a living trust, you can pass on property while avoiding the expenses and delays that often come with probate. A living trust is considered a valuable estate planning tool.
- Brokerage accounts: Any taxable investment account you open with an investment company or brokerage firm is referred to as a brokerage account. You may invest in stocks, bonds, REITs, CDs or other investment vehicles within a brokerage account.
How to Notify Creditors of Death
Once your debts have been established, your surviving family members or the executor of your estate will need to notify your creditors of your death. They can do this by sending a copy of your death certificate to each creditor.
When your creditors are notified of your death, they'll likely stop trying to collect unpaid bills while your estate is getting figured out. Your creditors will inform the three major credit bureaus (Experian, TransUnion and Equifax) of your death so they can prevent others from using your name to apply for credit. You also can contact Experian directly to update a loved one's credit report to show them as deceased and to get a copy of their credit report for probate purposes.
The Bottom Line
While it's unpleasant to think about what will happen to your debt when you die, it's something you should understand to protect your loved ones and prevent difficult situations for them in the future. Additionally, since debt often outlives the debtor, it's a good idea to keep your debt under control while you're living.