Debt can have a powerful grasp on your finances during your life, but what about debt after death? Of course, we aren’t talking about debt haunting you after you die, but rather your debt continuing to haunt your loved ones after you pass away. Without adding in extra debt to pay off, your death will be hard enough for your loved ones. So it’s important to examine what happens to our debt after we die. Are others responsible for our student debt? What about school loans?
The Default Scenario- Your Debt Is Your Debt Alone
Unless if there is something legally tying your debt to someone else, your debt is only your debt. However, your debt does not simply die with you. Your debt will have first claim on any assets you leave behind (your estate). Before your heirs inherit any of your property, all your debt must first be paid off either by cash you leave behind, or by selling off other assets in a process known as probate. One notable exception to this is any accounts with named beneficiaries. These are typically paid immediately upon death before the probate process. Any property left behind is then distributed to your heirs. Only if all your property is liquidated and there is still debt left over does that debt die with you.
The above is only the default scenario if there is nothing legally making someone else responsible for any of your debts. And although it is the default, it is not uncommon for debts to be linked to someone else.
The Marriage Connection
Perhaps the most common connection that your debt may have to someone else is your marriage. Of course, you and your spouse will take some loans out together- likely your mortgage for one. In all cases, these will remain your spouse’s responsibility after your death. But you will likely also have debt that you take out in your own name- credit cards or vehicle loans, for example. Depending on your state’s laws, even debt that you take out only in your name will become your spouse’s responsibility in the case of your death.
Nine states are known as community property states: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. Alaska is optionally a community property state. These states do not treat each spouse’s property as distinct. Rather, what’s his is her’s and what’s her’s is his. This includes debt, so in these states, your spouse would inherit debt that was only in your name.
If someone co-signs a loan with you to help you qualify for better terms (or qualify at all), they assume the same responsibility for the loan as you. You may have had every intention to treat the loan strictly as your loan after the co-signing, but if you die your co-signer will be on the hook for the remainder of that debt, whether that be your spouse, parent, grandparent or friend. Keep this in mind both when asked to co-sign and when asking someone else to co-sign.
Authorized Users and Credit Cards
Usually you can make another person an authorized user on your credit card. This often gives them their own card on the account and allows them to use it as they like. Authorized users, however, are not equal to co-signers of the credit card. This means that the credit card debt is technically not their debt, even if they incurred some or all of it. If you die, they will not be required to pay it back.
Authorized users are not completely off the hook, however. All activity on credit cards gets reported on the credit reports of all users. So if you die, and your credit card debt is not settled in probate, the fact that it was never closed in good standing will go on the authorized user’s credit report and will hurt their credit score. This is avoidable if the authorized user has themselves removed from the account promptly after the account holder passes.
Student loans can be a confusing category for many people because different loans are treated differently upon death of the borrower. Regardless of any other circumstances, federal student loans are forgiven upon death of the borrower or student. This is true whether you live in a community property state or not. In the case of PLUS loans, which the parent takes out on behalf of the student, the loan is discharged if either the student or the parent dies.
Other student loans, however, are not necessarily covered by the same provisions as federal student loans. As with other loans, spouses living in community property states would be liable for the borrower’s debt after debt, as would any co-signers (such as a parent).
Protecting Your Loved Ones
There are a few things you can do to protect your loved ones from inheriting your debt.
If you are taking on student debt, max out your federal student debt before turning to other options. And if you already have federal student debt, don’t consolidate your debt. Typically, consolidating your debt rolls it over into a private loan, which would be treated as regular debt.
Also consider carefully before you ask someone to co-signing for you. This includes having your spouse co-sign. Of course, there may be benefits to co-signing that outweigh the risks. By co-signing, you may get a better interest rate or approved for a larger loan. However, just be aware of the liability that co-signing adds.
To protect your inheritance from your debts, take full advantage of payable-on-death accounts. These include accounts such as retirement accounts that list beneficiaries, as well as insurance policies and annuities with death benefits.
Ultimately, it is important to understand your financial goals and how your debts affect those goals. Being aware of how your debt is treated when you die is important to creating a strategy to protect your loved ones from an extra financial burden.