Debt After Death: Don’t Fear the Reaper

According to a study in 2016, the average U.S. household carries $16,748 in credit card debt, $28,948 in auto loans, and $176,222 in mortgage debt. Total consumer debt in the United States is approximately $12.58 trillion. For those of us doing estate and financial planning, it isn’t difficult to see that dealing with what you owe is as important as what you own.

 

What happens with a person’s debts when they die?

Generally, this depends on the type of debt involved (secured or unsecured) and who borrowed it. “Secured” debts (loans made where the lender takes a security interest on the property) run with the property and survive the death of its owner(s). So, for example, a house with a mortgage or line of credit secured by the home transfers at the owner’s death to the persons who acquire it by death. In the case of joint owners, like a husband and wife, when one partner dies, the surviving spouse acquires the house and the debt that runs with it. If there is property owned in a trust, the beneficiaries of the trust acquire the property subject to the mortgage, and generally the trustee of the trust arranges for making payments on the mortgage with other trust assets until the house is sold and the net proceeds distributed to the beneficiaries. Or, if there is property that passes by a “beneficiary deed” or “transfer-on-death deed,” it is the beneficiaries who generally have the responsibility to pay any debt running with that property until it is sold.

The beneficiaries can agree among themselves as to exactly how to handle debt and other expenses on the property until it is sold and the debt is paid. Otherwise, creditors can seek legal action against beneficiaries of “transfer-on-death” property in probate court to try and collect.

“Unsecured” debt is trickier in terms of the death of the borrower.

For those who have joint credit card accounts, for example, in most situations, the surviving borrower will be responsible for any charges made by the deceased borrower.  When an unsecured debt involves only one borrower, the debt becomes part of his or her “estate” and is technically subject to the rules of the state regarding probate. And since the debt is part of the “estate,” it is payable only with estate assets.

However, in probate, there is a very formal procedure that the law demands in order for a “claimant” (a lender in probate terms) to be entitled to payment of their debt from the estate. The claim must be filed with the probate court within a certain period of time (usually no later than six months after the publication of notice of the opening of the estate), reviewed by the Personal Representative of the estate and, depending on the type of estate involved, approved by the court before it can be paid. The probate law also “ranks” certain types of claims as having higher priority of payment than others – for example, funeral expenses and taxes have higher priority than any judgments or “other claims” (i.e., unsecured debts) against the decedent.

Similar rules also apply to trustees of trusts.

Trustees can also publish notice of the death of a settlor of a trust which “starts the clock” for creditors to present their claims for payment under the “six-month” rule. Depending on the terms of the trust document, trustees also usually have wide latitude in the payment of the deceased settlor’s creditors as well as other expenses of administration, taxes, and other claims.

What happens if there are no assets in the probate estate to pay the claims?

Then, in those instances, the lender could be out of luck. Beneficiaries or heirs of an estate do not have a personal obligation to pay the debts of a decedent unless the rules regarding probate are followed. Some probate assets, such as household furnishings and cars of a certain marginal value, pass to the heirs of the estate and are exempt from claims.

Given all of these protections, creditors often are willing to compromise the amount of their claims in order to avoid the cumbersome process of probate and get some immediate cash to satisfy their claims. A Personal Representative or trustee of a trust should be aware of this and use the law to their best advantage, working with an experienced attorney, to compromise debts and provide additional value to the beneficiaries of an estate or trust.