What happens to debt when you die?

A woman sits in her window as she learns more about what happens to people's debts after they pass away

The unfortunate reality is that your financial struggles, such as credit card debt, outstanding medical bills, or your mortgage typically don’t go away when you pass away. They will instead—most likely—become the responsibility of your beneficiaries and estate. The process of having your bills paid and distributing what financial leverage you have left following your death is called probate. 

Taking the time to understand this process and how the type of debts you leave behind can impact your loved ones is one of the most important components of estate planning. This blog further explains how and why life insurance is one of the easiest ways to protect those you care about most.

How to Protect Your Family with Life Insurance

An easy way to financially protect your loved ones after you pass is by having a life insurance policy in place. A life insurance policy not only pays for end-of-life expenses, but it can replace lost income for both immediate and future expenses. A life insurance policy is a great safety net to have in order to prevent creditors from taking away the assets you would like to leave behind for your family, whether your loved ones end up being financially liable for your debts or not.

Who can inherit your debt?

After you die, there are a few parties who could end up responsible for paying your debts:

  • Joint owners or account holders
  • Co-signers on loans
  • Spouses – Spouses aren’t responsible for debts that predate the marriage. However, in certain states, community property from the marriage can be used toward paying off debts. 
  • People in charge of settling your estate’s debts if they don’t comply with probate laws

Secured Debts: Debts Backed by Collateral

A secured debt is a debt that is backed by collateral, which allows the creditor to take property or assets to pay off the debt. 

Mortgage and Car Loan Debt

The co-owner of the home or those who inherit the home are responsible for the remaining mortgage payments. If the payments cannot be maintained, the co-owner or the inheritors have the option to sell the house to prevent it from going into foreclosure.

Unsecured Debts: Debts Backed by Collateral

Unsecured debt has no collateral backing. Unsecured loans are usually given based solely on the borrower’s creditworthiness and promise to repay. 

Credit Cards, Student Loans, and Medical Debt

The joint account holder on your credit card, if there is one, would be responsible for keeping up with the payments and any associated debt. If no one else is listed on the account, your estate will be responsible for paying off any remaining debt. If your estate can’t cover the payments, creditors will usually take a loss and write off the amount.

Federal student loans should be forgiven when you pass away. Private student loans, however, will likely have to be covered by your estate. 

Medical bill debt can be complicated, and unfortunately, it typically doesn’t go away after you die. If you owe a large amount, it will likely be collected from your estate. If you owe a small amount, the provider may declare the bill uncollectible. If you are a Medicaid recipient, the state can collect payment for your medical bill debt from the payments you have made into Medicaid. How and if medical debt is collected after you die depends on many things, including where you live and the medical care provider.  

A final expense insurance policy, also known as burial insurance, is another easy and affordable way to cover end-of-life expenses. Final expense insurance can help cover funeral expenses, credit card debt, medical bills and any other outstanding debts you don’t want to pass on to your family members. 

Can creditors take your life insurance?

Generally, creditors cannot take the death benefit from your beneficiaries if you have outstanding debts thanks to insurance regulations that have been put in place. The only way a creditor would be able to do so is if the death benefits of your policy become part of your estate. The death benefit of your life insurance policy becomes part of your estate if:

  • All of your beneficiaries die before you and you never name new ones
  • You list your estate as a beneficiary

When you pass away, your estate will go through a legal process known as probate, which determines where your assets will go. Lenders are entitled to those assets and can claim life insurance money that becomes part of your estate before your loved ones get their share. If there’s any money left after this process, it’s distributed according to your will.

While these regulations will protect your beneficiaries from your creditors, if they are in debt, they are not protected from their own lenders. Once they receive the death benefit and it becomes part of their assets, this could be seized if they’re past due on their own loans.

Life Insurance Policies Aren’t One-Plan-Fits-All

A life insurance policy is typically exempt from creditors and can guarantee that your loved ones will receive money when you pass away. Figuring out what life insurance is right for you can seem complicated, but that’s what we’re here for. We can help you figure out what coverage is best for you and your family—whether it’s term life insurance, final expense insurance or another policy altogether.

We do the shopping. You do the saving.