What happens to your debts when you pass away is an important consideration for most consumers as this is the last thing they want their loved ones to worry about after they die.
To assume your debt will simply be scrapped would be detrimental to the financial well-being of those left behind.
Does this mean your family will inherit your debts? Not exactly.
“When you die, your assets and liabilities are transferred to your estate and the estate is then responsible for paying off debts and distributing assets according to your will,” says Sebastien Alexanderson, founder and debt counsellor at National Debt Advisors.
If the assets are distributed to them before the debts are settled, heirs may have to pay the debts from their share of the estate. How debt is dealt with after death is largely informed by whether the debt is secured or not.
“Secured debts are those guaranteed against specific assets which are tangible items taken as security for loan repayments. If payments cease, the bank can sell or use these items to recover the amount owed.”
Alexanderson says unsecured debts are the opposite of this.
“Nothing is attached to the debt and if payments stopped, the bank would not have anything to repossess. In these instances, to pay off debt, the bank must go to court and get an order charging for the sale of valuables to recover the funds.”
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The one who inherits the house pays the bond
He points out that when it comes to secured debt when you pass away, the person who inherits the house has the responsibility to pay off the balance of the mortgage on your deceased’s behalf. If it is a joint mortgage, the survivor is still responsible for the balance.
“Keep in mind that the house serves as collateral for the debt. So, if the debt is not repaid, the bank can repossess the house and sell it to pay off the debt.”
In the case of unsecured debt, it depends on whether there is enough money or assets to pay the debt in the estate. “While collection agencies may try to convince the heirs that they are legally required to pay the debts with their own money, the fact of the matter is, unless they were a co-signer to the debt, no one else has to pay anything towards the unsecured debt of the deceased.”
You can only inherit someone’s unsecured debt if the estate is dissolved and distributed before the debts are settled.
Another important financial aspect to consider is tax which does not disappear when you die. “If an estate earns income after death, it must pay taxes. The heirs of the estate may also have to pay taxes on inherited income. Furthermore, an estate tax may apply to the estate’s assets, which is separate from the income tax.”
One type of debt that can be forgiven after death is student loan debt, when the student dies or in some cases, the borrower’s parents. In these cases, proof of death must be provided.
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Tips to keep in mind
Keep these tips from Alexanderson in mind:
- Credit life insurance was designed as a protective layer for any eventuality that could possibly prevent you from being able to foot your debt bill. It can remove a huge burden from those left behind.
- An insurance policy for death in service is provided by some employers that pays out a lump sum if you die while still on the payroll.
- Life cover pays out an amount when you die and can be used to pay off your debts when you pass away so that you do not leave your family with having to face your debt problem after you die.
- Investments and savings accounts can be used to make sure you leave a healthy financial legacy for your family. A combination of both these tools could ensure your estate is in a healthy condition for your beneficiaries to appreciate even long after your pass away.
- Smart money management and family budgeting habits is a good legacy to leave behind. You can develop many positive habits and long-term techniques to help keep your credit score healthy as well as prevent debt from becoming a significant issue for you and your family.
Alexanderson says there are ways to minimise and mitigate family members inheriting debt, but the best way to ensure only positive things are left behind after death is to maximise your wealth and financial wellbeing now.