What Happens to my Debt When I Die? Is it Forgiven or Transferable?

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When you die, some debts are forgiven but most are collected from the value of your estate during probate. If your outstanding loans are greater than your estate, they will typically not be transferred to family members. However, anyone that cosigned a loan, is a joint credit card account holder or that wants to retain certain property may be held liable for your debt. In addition, your spouse may be liable for your debt if you lived in a community property state.

Term life insurance can be used to shield your heirs from debts or make sure your spouse can maintain their standard of living. Term policies are the cheapest form of life insurance coverage and can be tailored to the size of your debts, such as mortgages or auto loans.

What Happens When You Die?

While there is some variation depending on the laws of the state you live in, the process of what happens when someone dies is relatively consistent. First, the executor of your state, appointed by the court, obtains a record all your outstanding debts, generally by requesting a credit report or looking through your bills. The executor should then notify the Social Security Administration and all your lenders of when you passed away, sending certified copies of your death certificate and any key account information.

When you die, all your debts are passed on to your estate, so the executor will compile a list of all outstanding debts and determine the order in which they legally should be paid. The order varies by state and some forms of debt, such as medical bills or a mortgage, are typically given first claim. This process of aggregating assets, paying of debts and distributing any remaining to your heirs is called probate, and can take several months if you don’t have a clear will in place.

The majority of your assets immediately become part of your estate when you pass away, meaning creditors can come after them. However, that typically doesn’t apply to:

  • Life insurance
  • Retirement accounts, such as IRAs and 401(k)s
  • Brokerage accounts

Just note that if you haven’t specified a beneficiary for these assets, or your beneficiaries have passed away, they will be passed on to your estate. This is why it’s important to keep your designated beneficiary lists updated every few years.

Will Your Debts be Forgiven or are they Transferable?

Since your debts are transferred to your estate when you pass away, if your liquid assets (such as checking and savings accounts) are large enough to cover them, no debts will be passed on to your spouse or heirs. The situation becomes more tricky if:

  • Anyone cosigned one of the loans or is a joint account holder for a credit card
  • You have secured loans (such as auto loans or a mortgage) that exceed the value of your liquid assets
  • You live in a community property state (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington or Wisconsin)

In these situations, whether a debt is forgiven, transferable or could impact your family tends to vary according to the type of debt.

Student Loans After You Die

Federal student loans are forgiven when the student passes away. Similarly, federal PLUS loans are forgiven when either the student or their parent dies.

The rules for private student loans vary according to the lender and state. While some private lenders, such as Sallie Mae, will forgive the loan when you pass away, most will attempt to collect from your estate. If your estate doesn’t have enough money to cover the loan, it will only impact your family if:

  • They cosigned the loan, in which case they would be responsible for paying it
  • You were married when you obtained the loan and live in a community property state, in which case your spouse would have to pay it

If you don’t live in a community property state and no one cosigned the loan, the lender will attempt to collect from your estate but has no recourse if there’s not enough money. So, the student loan will essentially go away as the lender can’t collect from your family.

Now, this assumes that you were the student. If you were the cosigner of a private student loan, your passing may cause the student to need to refinance. This is because you were providing security to the lender that they would be paid and, without you as a backup, they may try to collect from the student.

Mortgage Loans When You Die

Your house isn’t usually considered part of your estate. So, for example, if your credit card debts exceeded the value of the rest of your assets, the credit card issuer wouldn’t be able to put a lien against your home. However, a mortgage is not forgiven when you pass away and will need to be paid.

Your spouse or the person that inherits your house will typically have the option to take over mortgage payments when you pass away. If they’re unable to make the mortgage payments and the outstanding mortgage cannot be covered by your estate, the person that inherited the house will have to sell it and pay back the mortgage. Otherwise, the lender will foreclose on the property.

Credit Card Debt After Your Death

When you pass away, the executor of your estate should notify credit card issuers as they will stop adding on any fees or penalties to the outstanding debt until the estate is settled.

Joint cardholders are responsible for an outstanding credit card balance if you pass away, however, authorized users of the credit card are not. Just note that if an authorized user attempts to use the credit card after you pass away, it could be viewed as fraud or they could be held responsible for any balance.

A spouse could also be held responsible for the debt if you lived in a community property state. If you didn’t have a joint cardholder and didn’t live in a community property state, available money will be collected from your estate but the credit card issuer would have to walk away from any debt in excess of that.

What Happens When You Die with Medical Bills?

Medical debt is somewhat more complex but, assuming you didn’t receive Medicaid, your family would likely only be held responsible if:

  • They made a financial commitment or guarantee to the medical institution. Given the high cost of care, this is often requested when a family member stays for an extended period at a hospital or nursing home.
  • Their legal relationship to you involves a “duty of support”. For example, if they claimed you as a dependent, they could be responsible for the cost of your care.

While the majority of states have filial responsibility laws, these are rarely enforced. Filial responsibility laws can require any adult children you have to pay for medical bills that weren’t covered by your estate.

If you received Medicaid, the state can make a claim against your estate for any money spent on your medical care after age 55. There are some caveats to this, so it’s a good idea to check your state’s regulations. However, this debt would not be transferable to your heirs and family members.

Car Loan After Your Death

Car loans are not forgiven at death so, if your estate can’t cover the debt, the person that inherits the vehicle needs to decide whether they want to keep it. If they do want to keep the car, your heirs can take over the auto loan payments and maintain possession of it. Otherwise, the car will be repossessed by the lender.

Debt Collectors & When Family Can be Held Responsible for Debt

Loan cosigners and joint account holders can be held responsible for debt, and family members may have to pay debts for inherited property they intend to keep. While community property states can only hold a spouse responsible for loans taken out during your marriage, half of the community property can be considered as part of your estate and used to pay creditors.

Assuming none of these situations apply, creditors are usually “out of luck” for any debts that can’t be paid by the value of your estate. Exceptions to this can occur if:

  • You distribute deathbed gifts - This can include any money or items of value given away just before you pass away. Creditors may be able to come after your relatives to get these assets added back to your estate.
  • Your family distributes any of your assets during probate - If your family gave out antiques, family heirlooms or any other items of value before your debts have been settled, creditors can try to get them added back to your estate.

It’s common for debt collectors to reach out to family members and pursue payment, but these inquiries should be directed towards the executor of the estate. However, if debt collectors suggest your family is responsible for debts they aren’t or harass your family, the collector should be reported to the state Attorney General’s office.

Using Life Insurance to Protect Your Heirs from Debt

Life insurance is commonly used in financial planning to help families cover debts once a loved one has passed away. Depending on the amount of debt and how long you expect it to be outstanding, you can choose between term and permanent coverage.

Term Life Insurance

Term life insurance is a great option if you have a particularly large amount of debt or know how long the debt will be outstanding. For example, if you have a 30-year mortgage for $300,000, you can purchase a term life insurance policy with a matching death benefit and term length. In addition, term life insurance policies are cheaper than other forms of insurance, so they’re usually the best choice if you need a particularly large amount of coverage.

When you purchase a term policy, you can name specific beneficiaries to receive the death benefit if you pass away. Upon your death, the beneficiaries file claims and are paid directly by the insurer, as the money isn’t considered a part of your estate. The only exceptions to this are if you don’t name a beneficiary or your beneficiaries pass away first. In these cases, the life insurance payout would be added to your estate and could be used to pay outstanding debts.

Joint Life Insurance

Joint life insurance policies are a form of permanent life insurance and are typically purchased by couples. Joint policies pay out upon the death of either you or the other policyholder. When a death benefit is paid depends on the structure of the policy:

  • First To Die - Pays a death benefit when you or your spouse dies, whichever comes first. This type of policy is usually preferred when you want to make sure your spouse can retain their standard of living. For example, you may purchase enough coverage to pay for an auto loan so they don’t lose their method of transportation.
  • Second To Die - Pays the death benefit when both you and your spouse have passed away. This policy is more often used in estate planning as it can help heirs to pay inheritance taxes or any debts that would be passed to them.

Credit Life Insurance & Mortgage Life Insurance

When you get a loan, you may be offered credit life insurance as a method of making sure your spouse or heirs don’t inherit your debt. Credit life insurance is similar to term life insurance, but the only beneficiary is the lender and premiums are more expensive.

We recommend that you don’t purchase credit life insurance and, if you’re concerned about debts being passed on, purchase a term life insurance policy instead. And you should not let a lender pressure you to purchase life insurance when obtaining a loan. Though there are some cases in which a lender can require you to provide proof of life insurance in order to secure a loan, they cannot mandate that you purchase coverage through them.

Mortgage life insurance is a form of credit life insurance and we don’t recommend it if you’re able to obtain a term life insurance policy elsewhere. However, if you have significant pre-existing conditions, some insurers will not offer a large enough death benefit to cover a mortgage. In these cases, if you want to make sure your spouse or children are able to stay in your family home, mortgage life insurance can be a helpful method of financial protection for your family.

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