Photo (cc) by Nicholas Ortloff Photography (Is Back)
If you die with money and possessions, everything is distributed based on your will. But what happens when you die in debt?
Here’s this week’s question:
I’m a single woman with no kids who is actively and aggressively trying to pay off my debt. I have a few health issues and worry sometimes about leaving this life without being debt free. My credit cards (from my stupid 20s) are paid off, and I’m now working on paying off my car loan, student loans and my mortgage. What happens if I pass away with debt? My father is still living, as well as my three siblings. Do they get stuck with my debt? I have a life insurance policy; it’s not very big. Does that go towards paying my funeral expenses or my debt?
Thanks in advance,
Life can be complicated. And as it turns out, death isn’t so simple, either — at least not when it comes to settling your debts.
When you die, your estate is born
When you die, your family may inherit your Beanie Baby collection, but they don’t inherit your debt.
What essentially happens is that the instant you shuffle off this mortal coil, a new entity is simultaneously born: your estate. “Estate” is just a fancy word for your assets, or stuff you owned, and your liabilities, or stuff you owed. If your assets exceed your liabilities, your estate has a positive net worth. If they don’t, it doesn’t.
Let’s explore how this all works by looking at a few common debts and methods of ownership.
Debts in your name alone
You might think your credit card company knows everything about you. But when you die, your bank doesn’t automatically get a memo. It just notices your bill is overdue and eventually passes it along to the collections department.
When you’re gone and your estate is born, it becomes the responsible party for your debts. The person serving as your surrogate, known as a personal representative or executor, gathers your assets, sells your stuff, pays your bills and distributes anything remaining to your heirs. If your estate owes more than it owns and there’s not enough to pay the bills, unsecured lenders, like credit card companies, just have to suck it up.
When I notified my father’s bank that he’d died, shortly after expressing their condolences, they began calling, writing and otherwise requesting the full payment of his credit card balance. They also implied I should pay it, since I was his nearest living relative.
This is not uncommon, but it is despicable. My father’s estate was responsible for his debts, not me. You’re less likely to run into something similar these days, because the FTC has since issued guidelines for debt collection from decedents’ friends and relatives. Here’s what they say:
… family members typically are not obligated to pay the debts of a deceased relative from their own assets. What’s more, family members — and all consumers — are protected by the federal Fair Debt Collection Practices Act (FDCPA), which prohibits debt collectors from using abusive, unfair, or deceptive practices to try to collect a debt.
In short, if an unsecured debt is in the deceased person’s name only, the debt is not passed on to heirs and family members. It’s owed only by the estate. If you die broke, or there isn’t enough money left over for all the creditors, they lose and you win. Except, that is, for the part about being dead.
Now the bad news. As CreditCards.com explains:
One situation in which someone else could end up shouldering your credit bill: If you share the account. If a spouse, family member, or business partner signed the card application as a joint account holder, then that person could be liable for the balance on that card, along with (or instead of) the estate.
The same goes for married couples who have joint bank accounts — and joint debt. Your surviving spouse might be legally responsible for the debt, even if you’re the one who rang it up. If the debt is in your name alone, however — in other words, you’re married but applied for the debt completely on your own — your spouse may not be liable for it. Unless, that is, you live in a community property state.
These states make it possible for your debts to pass on to your spouse:
- New Mexico
Here’s how the Law & Daily Life blog explains it:
Such “community property” is liable for debts incurred by either or both spouses during the marriage (regardless of personal liability). Should a spouse pass away, creditors in such states may have options, both inside and outside of probate, to try to attempt to recover for the debt.
That doesn’t necessarily mean your spouse will get stuck with the bill, but it makes it a bigger possibility.
You also need to watch out for secured debts — loans that are secured by an asset such as a house or car. You might think you’re doing a family member a favor by leaving them your car, but if there’s a loan on it, that loan may go with the car. The same is true with a house.
So if you’re planning to leave someone an asset with a loan attached, the nice thing to do would be to also leave them enough money to pay off the loan. If that’s not possible, then they may have to sell the asset to satisfy the lien, because it’s not going to be wiped out in the event of your death.
What happens if you co-sign a debt for someone who dies? Unfortunately, in many cases you could be paying the bill. A co-signer agrees to pay the debt if the original borrower can’t. So whatever the reason, if the primary borrower doesn’t pay, the co-signer may have to. This isn’t always true: For example, federal student loans are typically discharged by death, but private student loans may not be. If they’re cosigned, the co-signer may be on the hook. If they weren’t co-signed, the estate will be liable. You can read more about student loans after death here.
What you should do while you’re still alive
No matter how old you are or how much you have, if you’re an adult, you should have a will. A will is simply a list of instructions that lets those you leave behind know what you wanted done with your body and your stuff. It will be read by a judge in a process known as probate, and providing your wishes are legal (no, you can’t have yourself stuffed and propped on your favorite bar stool) it will be followed.
Getting a will doesn’t have to be complicated or expensive. (See our story, Estate-Planning Documents You Need Right Now.) And it’s important, even if you think you don’t own enough to make it necessary. Because without a will, everything you have is going to your nearest relative — do you really want your mom to inherit your vintage Penthouse collection? — and that person will also be responsible for settling your debts and taking care of all the loose ends you leave behind.
A will offers you the opportunity to put your possessions into the hands of those you’d like to have them, and could save your family a lot of hassle. If you don’t have one, get one.