Debt is everywhere. When you look at all types of debt, including home mortgages, approximately 80% of all Americans are liable for some form of debt.
So whether you’re serving as the executor of an estate or planning ahead in the event of your own passing, the implications of debt after death will affect your family.
Let’s see how it works.
What Happens to Debt When You Die?
Debt doesn’t just disappear when you die. It is up to your estate to pay the debt that you owed at the time of your death.
Someone’s “estate” is just a term courts and lawyers use to talk about someone’s unique financial life — a.k.a. The summary of all of their assets, liabilities, property, and so on.
Let’s get hypothetical
Say that you plan ahead and die testate (with a will) rather than intestate (without a will). You’re off to a good start, as your attested will serves to determine the executor of your estate and the overall distribution of your assets.
In your will, you direct a variety of specific gifts, naming both the assets and specific beneficiaries that will receive the assets. You also include general gifts, naming the specific beneficiaries that will receive a general asset.
Let’s also say you want to leave any remaining assets to your favorite charity, so as a last measure you create a codicil to the will (an addendum of sorts) and include a residuary gift to the charitable organization of your choice.
That’s a lot of preparation. When you pass away, the estate settlement process will be directed by the thorough will that you’ve written. Good stuff.
But there’s one problem—you face a large sum of debt in your mortgage and unpaid credit card bills.
What happens next?
To understand that, we need to look at the order of estate payments and distributions within the probate process:
The Order of Distribution
When people pass away, most estates go through what is known as probate, which is just the government’s way of making sure that when a person dies, the right stuff goes to the right people (including the taxes the government wants).
During the probate process, your debts and taxes must be paid before any distributions to beneficiaries are made.
As a general rule, the distribution steps within the probate process follow this pattern:
- The estate assets are collected
- Debts and taxes are paid from the estate assets
- The remaining assets are distributed to the beneficiaries according to the will
Why does this matter? Well, you can see by these three steps how your estate settlement plan will be drastically altered if you have an accumulation of debt.
It doesn’t matter if you’ve written the best will in the world and hired the smartest lawyers—your debts must be paid.
Debts must be paid first, so any debts that are paid off is only less money for your beneficiaries or heirs to receive.
If you have more debts than assets, then your beneficiaries or heirs won’t receive a dime of your money. Nothing. Nada. Zip.
What if you don’t have enough cash to pay the debt?
If your estate is illiquid, meaning that not enough cash is available to meet the needs of the estate settlement process, then your executor or executrix will need to sell some of the tangible assets within the estate.
This might be your house and land, your cars, your baseball card collection, or anything else of value that can be sold to raise liquidity (cash).
It’s important to understand that some of the beneficiaries named in your will might not receive the assets that they were originally set to inherit if those assets need to be sold to raise cash.
If your nephew thought he was getting your Babe Ruth rookie card but the card had to be sold to raise cash to cover debts, then your nephew is just out of luck. There’s no crying in baseball, kid.
What if the debt exceeds all of the estate assets?
What if you died with a great amount of debt but only a few assets? Well, not all of your creditors will be repaid.
The order in which a creditor receives payment varies from state to state, but whether a creditor is first in line to receive usually depends on whether the debt was secured or unsecured.
Secured debt: Secured debt is backed by an asset, which we call collateral. In most cases, the asset is the house or a car. If the estate owner cannot pay off the debt, then the lender can take back the asset.
Unsecured debt: Unsecured debt does not have any collateral, meaning that the lender is unprotected if the borrower defaults on the loan. Examples of this type of debt are credit card debt, medical debt, or personal debt.
Because secured debt is backed by collateral (the physical asset), secured debts are almost always repaid. After all, the lender can seize the asset if the borrower cannot pay the secured debt.
Unsecured debt is more likely to go unpaid, as there is no collateral backing the loan. But some types of unsecured debt—like medical debt—receive priority in the probate process and must be paid first.
What happens to medical debt when you die?
Like most other forms of debt, medical debt does not disappear when you die. Your medical debt must be paid from your estate.
Although it is an unsecured debt, meaning that there is no collateral to back up the loan, medical debt is often given preference in the estate settlement process. Your estate will likely need to pay off outstanding medical debt before anything else can be paid off.
In addition to receiving top priority, medical debt is often the most complicated type of debt to pay off. If you had insurance during your lifetime, your executor will need to consult with insurance to see which of your accumulated medical bills are covered by your insurance plan. In most cases, this process of determining medical debt will be both lengthy and complex.
To know exactly how the medical debt needs to be paid, you’ll need to know the specific probate laws of the estate’s domicile. Each state is different, so understanding the local court’s laws will guide you in determining the steps. Depending on how debt is owned (e.g. in community property states), sometimes surviving spouses can be responsible for medical debt.
If you are dealing with a high amount of medical debt and are worried your family may be liable after you pass OR are trying to figure out if you are liable for the deceased’s medical debt, these are the questions that should be answered by a probate or estate settlement lawyer and not the internet, unfortunately. Some situations are too specific!
What happens to student loans when you die?
Student loans are treated differently than other forms of debt and are often forgiven when the borrower passes away.
Now, why did we use the term “often?” Aren’t student loans always forgiven when the original borrower dies?
No, not necessarily.
Federal student loans and PLUS loans are automatically discharged when the borrower passes away. Your family or executor will need to provide a death certificate to your loan servicer to certify your passing, and then the death will be discharged.
Private student loans are not treated the same way, however. It is up to your private loan service provider to choose whether the debt is discharged or not.
In some cases, the private loan provider might choose to discharge the loan as a courtesy to the deceased’s family. But there is no legal requirement or rule stipulating that the private loan company discharges the debt upon the borrower’s death. It’s up to the company’s discretion.
What happens to credit card debt when you die?
Your credit card debt will not be discharged upon your death. Outstanding credit card debt must be paid by your estate after your death.
Credit card debt is no different than most other forms of debt. It does not disappear when you pass away.
Because it is unsecured debt, meaning that there is no physical property or asset to back up the loan, credit card debt is typically one of the last forms of debt to be paid from the estate. Other forms of debt, like medical bills and secured loans, will be paid first.
But… credit cards are unique because spouses or family members will often set up cards as joint owners.
If one joint owner passes away with credit card debt, does that owner’s estate just pay off the debts?
That’s where things get a bit more complicated. It takes us to our final question:
Will my family inherit any of my debt?
Yes, your family might inherit your debt if they are listed as joint signers or were married to you in a community property state.
We’ve operated under the assumption that your estate will pay off any remaining debts when you die. But that’s not always the case.
Let’s look at a couple of examples:
Example 1: A joint credit card
You set up a joint credit card with your son. You are both liable for the expenses on the card and for any accrued debt. Unfortunately, you miss your credit card payment for a few months in a row and rack up approximately $15,000 in credit card debt.
When you pass away, your estate will not be on the hook to pay the credit card debt. Instead, your son—the other joint owner—will be the one who inherits the credit card debt.
The good news in this example? Most credit card lenders won’t allow you to add a joint owner to your line of credit. The lender may allow for an authorized user, but they likely won’t allow you to add a joint owner.
This is good news from the perspective of estate settlement, as it ensures that there won’t be a joint owner in the future who is responsible for any outstanding debt.
Joint credit cards aren’t the only example of a surviving joint signer being responsible for the deceased joint signer’s debt. The same example applies to anything that you co-sign or agree to with another individual.
As a rule of thumb: if you co-sign any contract, bill, or agreement with another individual, you are agreeing to assume the other individual’s debt in the event of their death.
Sure, you might trust that close friend or relative. But before you agree to co-sign a rental agreement, contract, medical bill, credit card, or loan with them, carefully consider whether you’re willing to take over the other person’s debt if anything happens to them.
Let’s take a look at a second example.
Example 2: A community property state
There are nine states in the United States that follow “community property” laws. These laws stipulate that any property a spouse accumulates during marriage is owned equally between the two people. This property is held as community property between both spouses.
Earned income is one of the easiest ways to explain community property. Let’s say a couple lives in a community property state. The wife and husband both work.
The wife makes $200K each year, but the husband only earns $100K per year. Together, the husband and wife each own $150K—$300K split equally—regardless of which spouse earned more during the year.
The nine community property states are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin.
Just as earned income is split equally between both husband and wife, so too is any debt that is accumulated during the marriage.
In a community property state, the surviving spouse is responsible for any debt that the deceased spouse incurred during the marriage. This includes private student loans—or any other form of personal debt—that the deceased spouse accrued.
It doesn’t matter whether the surviving spouse agreed to these debts or not. The surviving spouse is still responsible and must pay off the debt.
As with many aspects of estate settlement, understanding your state’s specific laws is vital as you work to plan for the future. Each state is different, so don’t assume that the laws that apply to debt in one state apply to debt in the same way in another state.
Do some digging and research to learn more about your state’s debt laws. It could mean the difference between a seamless probate process and one that is very difficult.
Believe us, your future heirs and beneficiaries will thank you.