What happens to your debts when you die? Do lenders just take the loss, or can they compel surviving family members to pay the outstanding balances? The answers to these questions vary according to the type of obligation, the participants in the borrowing agreement, and even one’s state of residence. And correctly untangling a decedent’s financial obligations may require legal assistance.

Generally, when someone dies, their personal debt is not passed on to surviving family members; all debts are either paid from the assets of the deceased’s estate, or written off. However, several factors may result in exceptions to this broad statement.

“Personal debt” is debt incurred exclusively by an individual. For several situations, i.e. if the agreement includes a co-signer, the loan is titled as a joint account, or an asset associated with the debt is considered community property, other parties may find they are responsible for the outstanding balance.

In the probate process, personal assets are liquidated to satisfy creditors before heirs receive the remainder of the estate. If the debt was secured by another asset (such as a home or automobile), a lender may take the asset to satisfy the obligation. This doesn’t require payment by survivors but may result in financial distress because they are deprived of the future benefits of these collateralized assets.

Consider this example from a letter to Steve Bucci, a credit counseling expert who writes a syndicated financial column as the “Debt Adviser.”

Dear Debt Adviser:

My husband died and left behind a house with a mortgage payment. My name is not on the paperwork as a co-signer, but I do live in the house. This was on purpose. I was kept out of the mortgage so I wouldn't be held responsible if something happened to my husband. Now something's happened, and I'm not sure what I need to do to keep the house. I have not told the mortgage company of my husband's death, though I have been trying to keep paying the bill. What should I do? Do you have any advice for paying a mortgage after the death of a loved one?

In a typical estate arrangement the surviving spouse inherits the home. However, because the husband was the sole borrower, his death means the lender could demand the outstanding loan be paid in full. If the husband’s estate does not have other assets, the bank could take possession of the home to satisfy the loan, leaving the widow without a place to live.

Bucci tells the widow about a 1982 law that limits a lender's ability to enforce a due-on-sale clause for an up-to-date mortgage when the owner of the property changes. But he adds, that “doesn't mean that the lender won't try or that the lender might not try to tack on a fee when it shouldn't.” And she needs to find an attorney right away.

An April 22, 2014, New York Times article reported another instance where lenders can demand full payment at the passing of  a borrower – but in this situation, it’s the co-signer who dies.

Because students usually have limited employment and credit histories, student loans from private financial institutions often require a co-signer, typically a parent or other relative. The expectation is that the student graduates, finds employment, and faithfully repays the loan; a co-signer only gets involved if the student/graduate fails to make payments.

But the repayment period for student loans can extend for several decades. During that time, what happens if a co-signer dies? Since the lender has lost an additional level of financial security with the co-signer’s death, “even graduates who have good payment records can face sudden demands for full, early repayment of those loans, and can be forced into default.”

On the other hand, there may be debts that heirs don’t have to repay, even if they can. Another example:

A husband dies with $25,000 in credit card debt. He also owns an in-force life insurance policy for $250,000, with his wife named as the beneficiary. Since life insurance proceeds are distributed directly to heirs, and not subject to the probate process, creditors may not have a legal claim to these assets to satisfy a debt. Referencing Bucci’s earlier comment, this doesn’t mean creditors won’t attempt to ask heirs to repay these debts – they have nothing to lose by asking. And heirs, not knowing the legal status of the debt, may comply.

To get a sense of the financial distress that often accompanies unresolved debts after a family member passes, you might want to read a few entries from the bills.com website (www.bills.com), especially the “Comments” sections that follow many articles.

Two recurring observations:

1. How a death might affect their debts is rarely part of consumers’ decision to borrow.

2. In almost every situation, adequate life insurance protection makes it much easier to resolve debt issues in an estate.

Bucci goes directly to this at the beginning of his answer to Linda’s letter:

“I'm sorry to hear that your husband passed away. I'm doubly sorry that you're now stuck in a financial bind. You're not alone, unfortunately. Women tend to outlive men, yet many fail to plan for this eventuality.”

“In the best of worlds, your husband would have had mortgage insurance or a life insurance policy that would allow you to pay off or pay down the home loan. From the tone of your question, I gather this is not the case...”

If you have debt, not having life insurance to clean up whatever might be due on your passing may put your survivors under unnecessary financial duress. On the other hand, having life insurance gives them both the time and resources to handle the process correctly.

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