What Happens to Debt When Someone Dies?

Key Points – What Happens to Debt When Someone Dies?

Understanding the Rules with Different Types of Debt
The Importance of an Up-to-Date Estate Plan
What Happens to Debt When Someone Dies Can Depend on Where You Live
Working with an Estate Planning Attorney (as a Part of Your Team of Financial Professionals)
5 Minutes to Read

What Happens to Debt When Someone Dies?

Death and debt obviously aren’t subjects that are fun to talk about, but avoiding discussions about them can lead to more problematic scenarios. We’re going to discuss what happens to debt when someone dies for a couple of reasons. This is a crucial component to estate planning.

One, we want you to be prepared for what happens to debt when someone dies if one of your loved ones dies with debt. And two, we want to make sure that you and your loved ones are educated on the difference between good and bad debt. Eliminating as much of that bad debt as possible before retirement plays a huge role in having a stress-free retirement.

Debt Doesn’t Die When You Die

Unfortunately, debt doesn’t just disappear when someone dies. And part of the reason that debt can be such a complicated issue when someone dies is that several factors play into it. The answer to what happens to debt when someone dies depends on the type of debt, the decedent’s assets, and if there was a joint account holder or co-signer on the decedent’s accounts.

In short, your debts will become a part of your estate when you pass on. If you have a will, the executor you select will be responsible for settling your debts as a part of settling your estate. Having a detailed will, or better yet, a trust, can make the process of settling your estate less complex for your heirs.

According to the Federal Trade Commission, if the decedent’s debt exceeds the estate, your heirs typically won’t be required to pay off your debt with their own money if there aren’t sufficient means within your estate to do so. Oftentimes, that debt will go unpaid. However, you and your loved ones need to know that there are exceptions to that. Those exceptions include:

If you cosigned a loan with the decedent.
You’re the surviving spouse and reside in a community property state (Arizona, California, Idaho, Nevada, New Mexico, Texas, Washington, and Wisconsin).
You’re the surviving spouse and reside in a state that requires you to pay specific types of debt, such as certain health care expenses.
If you were the executor and didn’t comply with the probate courts.

Is there a chance that you could fall under one of those exceptions? Let’s review a few scenarios involving different types of debt so that you can have more clarity about what happens to debt when someone dies.

What Happens to Medical Debt When Someone Dies?

Your estate is usually required to pay any unpaid medical bills after you die. The executor of your will becomes responsible for settling those medical debts. However, different states can have some very specific rules when it comes to paying off medical debt of someone who has died. We highly recommend consulting an estate planning attorney so that you fully understand your state’s specific rules.

Medical debt—and all other debts—needs to be paid by the estate first in order for any heirs to inherit assets from an estate. If your estate can pay off all your debt, your estate is solvent. If your estate can’t pay off all your debt, it’s insolvent. This is where it can get tricky, as it comes down to how creditors prioritize payments.

Will Creditors Write Off Your Estate’s Medical Debt?

Let’s say that you pass away with $75,000 in medical debt but only have $50,000 in your estate. In this case, your estate is insolvent. But will your heirs need to pay the remaining $25,000. In most cases with medical debt, creditors will write it off. But there are exceptions, including:

Living in a community property state.
If you have cosigned medical bills. If someone else signed off on paperwork for medical treatment you received, they could become responsible for paying off any debt that’s not covered by insurance. In the end, it varies on the paperwork that’s being cosigned and that state you’re in.
Filial responsibility laws can come into play here as well. However, Medicaid usually prevents them from being enforced. Keep in mind though that Medicaid could attempt to recover benefits from your estate, though.
And speaking of Medicaid, let’s briefly touch on Medicaid estate recovery. Are you a Medicaid recipient? If you’re 55 or older, Medicaid could try to recover payments it made for various health care expenses. Medicaid would pursue that money from your estate rather than your heirs. Note that this Medicaid recovery doesn’t apply if you have a surviving spouse, you’re under 21, or are disabled/blind child.

If you’re the executor of a will of an insolvent estate, the decedent’s life insurance policy can also be a useful tool. Remember that the death benefit that a beneficiary gets from a life insurance policy isn’t part of the decedent’s estate.

What Happens to Secured Debts When Someone Dies?

A secured debt uses collateral to back up the loan. Examples of secured debts include home and car loans—the home or car would serve as the collateral. Let’s use mortgage debt as an example.

When someone passes away, the equity in their house is one of the assets that becomes a part of their estate. Any balance remaining on the mortgage must be paid to avoid foreclosure. All those expenses can be paid from your estate by your executor out of your estate.

If your heirs are unable to afford your mortgage, they have a few options. They can sell your home, refinance it, or let it be foreclosed. It is important to note, if the house is foreclosed, any equity on the home is lost to the bank. Therefore, if your heirs cannot afford to continue making payments with the estate it is advised to sell the home if there is equity and to only foreclose/short sell if there is no equity. They can also use assets from your estate to pay off your mortgage.

If your estate can’t cover the remaining debt after the sale of the collateral, the lender may have to write off the balance, and it generally does not become the responsibility of surviving family members, unless they co-signed or guaranteed the loan.

If your mortgage is worth more than your home, the bank may allow a “short sale” for less than what is owed and may even waive the deficiency for your heir.

Tax debt may also be due following the passing of a loved one. There are typically taxes involved with the property left behind that take the highest priority of all the debts.

What Happens to Credit Card Debt When Someone Dies?

If you have credit card debt when you die, your heirs won’t be responsible for it as long as they aren’t a co-signer. The credit card companies can contact the executor of the estate for payment but there is a limited time in which to do so.

Getting Peace of Mind from a Team of Financial Professionals

As you can see, what happens to debt when someone dies doesn’t have a simple, straightforward answer. Are you trying to work toward being debt-free (and eventually having a debt-free estate) or concerned about what could happen to a loved one’s debt when they die (and how that could impact you)? If so, let us know and schedule a conversation with us here.

Dealing with complex issues involving debt can be a lot to handle on your own. It’s not worth risking one small oversight or doing guesswork with situations involving debt and/or fallout of the death of loved one. It’s also a lot to ask of one financial advisor to understand the many rules that are at play here. This is why it’s critical to work with a team of financial professionals.

At Modern Wealth, we have estate planning specialists that work alongside our financial advisors to thoroughly assess your estate planning needs. With estate planning being one of the pillars of financial planning, what happens to debt when someone dies is a question we’re used to answering. Please don’t hesitate to reach out to us if you’re asking yourself that question so we can walk through your unique situation with you.

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Investment advisory services offered through Modern Wealth Management, LLC, an SEC Registered Investment Adviser.

The views expressed represent the opinion of Modern Wealth Management an SEC Registered Investment Adviser. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Modern Wealth Management does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.