To be in debt is to owe a corporation or an individual for money borrowed. When a debt cannot be settled by the borrower in their lifetime, it is often paid with the estate they have left behind. The most common effect of this is that your beneficiaries may not receive as much as they were expecting if its value is needed to pay off your debts. In some unique cases, a spouse, close friend, or family member may be held responsible when the estate cannot fulfill payment. Below we touch on the different types of debt that exist and if they carry over in death. 

Types Of Debt And Their Impact

In death, debt is typically paid off with the estate the borrower leaves behind. Two types of debt, secured and unsecured, determine how that estate is used.

Secured Debt

Secured Debt is backed by the promise of collateral if left unpaid. This collateral is a safety net for the lender and is often made up of the asset the borrower is seeking the loan to obtain. A lawyer, like an estate planning lawyer, can tell you that typical types of secured debts are car loans, mortgages, home equity loans, and business loans. If the borrower defaults on a payment, the bank will seize the collateral backing the loan. 

Secured loans are considered less risky to both the lender and the borrower due to the specific collateral that is agreed upon if payment cannot be made. The asset (a car, a house, or other real estate property) is taken, but nothing more is at risk. When the borrower dies, if the estate cannot pay out the value of the remaining secured debt, the collateral may be sold, refinanced, or simply handed to the lender. You may also plan ahead and have your estate plan lay out a trust or other entity to repay the secured debt over time after your death. 

Unsecured Debt

Unsecured Debt is riskier for the lender because it is not backed by any agreed-upon asset and is based only on the borrower’s credit score as a benchmark of their likelihood to pay the debt back. A lender will often install an interest rate to an unsecured loan, set up as the “cost” of the loan, eventually equaling the total value paid back to be more than the original amount borrowed. The interest rate as well as the overall value of a loan will depend on the borrower’s credit. Missed payments will negatively affect the borrower’s credit score, hurting their chances of receiving any future loans. Typical types of unsecured loans include credit cards, personal loans, student loans, and medical bills. In the borrower’s death, the value of their estate will be used to pay off any active unsecured debt. If the value is not enough, an unsecured debt will often go unpaid and be written off by the lender. 

When Responsibility Falls On Others

In most cases, your debt is your own and the assets you leave behind will be used to pay back any outstanding value in your death. Situations where others may be held responsible include:

  • A loan included a co-signer. Some lenders will require a co-signer before entering into an agreement with a borrower. In the event that the borrower cannot pay off this debt, the co-signer will be held responsible. 
  • Your state law requires spouses to pay a particular type of debt. It is important to do some research into your own state’s specific laws about how debt is handled in the event of death. 
  • An individual is made the executor or administrator of your estate in death. This individual will be responsible for managing how your debts are paid with the value of the estate. 
  • You live in a community property state. You live in a community property state where surviving spouses are required to use jointly held property to settle outstanding debts. In these states, community property is defined as an asset that is automatically shared between spouses if it is acquired during a marriage. As of 2023, current community property estates include Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.

Importance Of Estate Planning

The ideal method of making sure your debts do not carry over is to pay them out within your lifetime. Since this is not always possible, including debt payment in your estate plan will streamline their payment and head off any surprises. The organization of one’s personal debt can vary significantly based on the individual and the unique agreements they have entered. Our friends at McCarthy Law, LLC know that the best way to have a complete understanding of your debts and what will happen to them is to enlist the help of an estate planning attorney. Contact a local law office to look at your debt picture and how it might impact your estate planning.