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.
Table of Contents
- What Happens to My Debt When I Die?
- How to Protect Loved Ones From Inheriting Debt
- How Much Life Insurance Do I Need to Cover My Debt?
- How Do Creditors Treat Life Insurance?
In addition to your debts, it’s imperative to plan for your digital assets before you die. Learn what to consider and why it’s important.
What Happens to My Debt When I Die?
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.
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.
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
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 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.
See what you’d pay for life insurance
How to Protect Loved Ones From Inheriting Your Debt
If you’re concerned about your loved ones inheriting debt, you need life insurance. It’s the best way to protect your loved ones from financial ruin because:
- Life insurance skips probate, meaning your beneficiaries get paid faster.
- Life insurance death benefits are tax-free.
- Creditors cannot come after life insurance when paid to a beneficiary.
- Your beneficiaries can spend the death benefit money however they want.
- Life insurance is affordable protection.
For secured debt that gets passed down, like a mortgage or auto loan, your heirs could let the lender repossess the asset. But wouldn’t you like them to be able to decide that on their own?
With life insurance, your loved ones could choose to remain in their home and use the life insurance money to keep paying the monthly mortgage payments. Imagine how beneficial this would be to your family. Instead of being forced to move out of their home after your death, they can stay.
They’re already grieving your loss. Adding the stress of trying to pay bills without your income is an unnecessary struggle. Life insurance protects their financial futures.
For unsecured debt that gets passed down, instead of the estate executor selling off assets to pay debts, the life insurance money can pay these bills. With life insurance in place, your heirs can choose to keep assets that may have financial and sentimental value.
Learn more about the benefits of life insurance for families and its different uses.
How Much Life Insurance Do I Need to Cover My Debt?
Term is the best type of life insurance to protect your loved ones from going into debt trying to pay off your debt.
- You can choose how long you want coverage to last.
- You can choose how much coverage to buy.
- It’s the most affordable type of life insurance.
Term life insurance is designed to provide coverage for a specific period of time, the “term.” The term length options range from 10-40 years.
Most term policies have the option to convert some or all of your coverage to whole life insurance before the term is up.
Your ideal coverage length depends on your needs and budget. The longer the term, the higher the premium. If you can, buy a term length that equals or exceeds your longest financial obligation.
- If you have a 30-year mortgage, buy a term policy with a 30-year term.
- If you want to pay for your child’s education and she’s five years old, buy a 20-year term policy to ensure protection is there through her college years.
- If you’re nearing retirement age and you and your spouse are working on paying off remaining debts as you get ready to downsize, a 10-year term policy may be sufficient.
How much coverage you need also depends on your needs and budget. I’m sure you’d love to leave your family $10,000,000 upon your death, but this amount may not be affordable or justifiable. Insurance companies don’t want someone to be worth more dead than alive.
Ideally, buy enough coverage to replace your income, cover large financial obligations, and pay for final expenses, such as your funeral.
In addition, medical debt doesn’t die with the patient. If you die prematurely, in many cases, it’s due to an accident or serious illness. Requiring medical services goes hand-in-hand with these causes of death.
Even with health insurance, medical debt can cripple a family’s finances. Life insurance can be used to pay your medical bills after your death.
Unsure how much life insurance you need? Our life insurance calculator is free and easy to use.
What About Life Insurance Through Work?
Most employers offer some amount of life insurance for free or heavily discounted as part of your benefits package.
Even if you have coverage through your employer, it won’t be enough to cover your debts, and you should consider an individual policy, as well.
How Do Creditors Treat Life Insurance?
Creditors can make claims against an estate if they are owed money. However, there are certain assets they cannot go after, including life insurance.
To ensure your life insurance is exempt from your creditors, be sure to name a beneficiary on your policy. Also, name contingent beneficiaries in case your primary beneficiary is unable to accept the funds.
If there is no named beneficiary or the named beneficiaries predecease you, the proceeds will be paid to your estate. In this situation, the life insurance funds are then available for creditors to claim.
|Note: Life insurance isn’t exempt from your beneficiary’s creditors. Once your beneficiaries receive the death benefit, their creditors can access it. To eliminate this risk, you can set up your life insurance policy to include a spendthrift clause.|
With this clause, the insurance company holds the death benefit proceeds in a trust and pays your beneficiary in installments versus a lump sum. Creditors cannot go after the insurance company for any money owed by the beneficiary.
Naming a trust the beneficiary of a life insurance policy is another way to protect the death benefit from your heir’s creditors. Because the trust is the life insurance beneficiary, it keeps the death benefit out of the reach of the creditors.
A trustee manages the death benefit funds and pays your heirs according to the instructions you leave in the trust. Many different types of trusts can be set up with this spendthrift provision.
Get Life Insurance to Protect Loved Ones From Debt
Life insurance can replace the income you provide to your family. It can also ensure they don’t go into debt paying off your debt.
The sooner you purchase life insurance, the cheaper it is. Your life insurance rates are based on a number of factors, your age being a big one.
Want to get life insurance quotes without giving away your contact information? Look no further.
Our quoting tool shows you term life insurance quotes instantly. When you’re ready to apply, the online application only takes a few minutes to complete. After you submit it, you’re assigned a dedicated Quotacy agent who will guide you through the process and answer any questions along the way.
Get a quote today. You may be pleasantly surprised at how affordable it is to protect your loved ones from financial struggles.