Published November 02, 2011
Death is a fact of life, and when someone dies, the deceased's family naturally may wonder what will happen to his or her mortgage, auto loan, credit card bills, unpaid income taxes and other debts.
The simple answer is that debts become part of the deceased's estate and typically should be paid before the remaining assets are distributed to the heirs.
Beyond that, debts after death are a very complicated subject, best approached with professional help, says Martin Shenkman, an estate and tax planning attorney in Paramus, N.J.
"When somebody dies, the executor or personal representative, different lingo is used depending on which state you're in, is charged with marshaling the assets for the estate and paying all the debts." Shenkman says.
Exactly how debts should be paid depends on the nature of the debt, the terms of the deceased's will and state law. For example, a loan collateralized by an asset usually stays with the asset, which means someone who inherits a house might get a mortgage as well. Someone who receives a car might get an auto loan to go with it. However, sometimes a debt may be paid off by the estate.
Executors and heirs also need to consider the possibility of hidden debts. To find out about undisclosed loans -- or to ensure there aren't any -- an executor can monitor the deceased's mail, search for P.O. boxes in the local area, review recent bank statements and speak with the deceased's financial advisers, Shenkman says.
Credit card bills can be among the easier debts to resolve, unless the estate is insolvent. That's because credit card companies may reduce or stop the accumulation of interest and fees on an account once they're notified of a death. They might even, as Shenkman says, "accept a flat payment and call it a day" since they know resolving an estate can take months.
Debts also can come to light when a legal notice is published, as required by law in most states, says Michael Halloran, a wealth management adviser at Estate Strategies Group in Jacksonville, Fla.
"Before the estate can go through the court system, you have to publish, 'Mike Halloran died, and I'm the executor or personal representative of the estate, and if we owe you anything, you need to tell me,'" Halloran says.
Creditors usually have a 60- or 90-day period in which to respond to a notice.
Debts after death can become even more complicated if the deceased owned a business or guaranteed or co-signed someone else's loan, Shenkman says. The estate may be responsible for such debts, depending on the ownership structure of the business and the legal wording of any loan guarantees. Again, legal advice is a wise investment.
Another complication is some assets may be shielded from certain creditors. For example in Florida, a life insurance policy is safe from most creditors, Halloran says. In other states, no assets are protected. Again, the word "may" should be emphasized due to differing state laws.
Assets transferred through joint ownership or community property generally don't escape the rules, though collection may be more difficult for creditors, in some cases. In other cases, the asset may simply be repossessed. "Say I own a car jointly with Sue, and I die," Halloran says. "If the bank has the collateral on the car, they can say, 'Sue, you have a choice. Mike died, but if you don't pay us, we are taking the car back.'"
If an estate is insolvent, meaning the assets aren't enough to pay off the debts and the bequests in the will, the executor must sort out some tricky and sensitive issues. Shenkman says he's seen an increase in such situations due to the poor economy.
"If there is insufficient money to pay off all the debts being claimed, you need to know legally what the priorities are of who gets paid or who doesn't," he says.
Such situations can get ugly because people may be grieving the death of the relative.
"When someone dies, it's a very emotionally charged event for the family and loved ones. When you combine that with the potential of not getting an inheritance but instead having to deal with debt, you're really talking about a hypercharged situation," Shenkman says.