Can You Inherit Debt? Signature Required
Perhaps you have managed your finances well and have incurred no debt, or you already paid off your debt. It would suck to have someone close to you die, but it makes it worse to have it negatively impact your own positive situation.
Although it rarely occurs, it does happen. You could have a family member such as a parent or child die, leaving you with their debt or your spouse could die and you would need to pay off the debts or your business partner could die and leave you with debts to pay off.
As much as that sucks, it can and does happen. Let’s look at how each scenario might play out.
Can You Inherit Debt from Your Parents?
Technically, you do not inherit the debt. The estate of the person inherits the debt. Your estate must pay your debts before distributing the assets to the beneficiaries. The length of time provided for a person or organization to file a claim to an estate differs whether it occurs in probate court or via a will and testament or trust.
Mortgage Issues
The estate must pay the outstanding bills including credit cards, mortgages, and other loans. You can deal with these debts in a few different ways. With respect to the mortgage, you can do the following to avoid spending estate funds:
- Assume the mortgage with its current terms,
- Refinance the mortgage to obtain hopefully better terms,
- Request a short sale,
- Allow the bank to foreclose.
If your parents took out a reverse mortgage, you must pay the remaining balance plus the interest accumulated.
Medical Bills Issues
The estate must pay any existing unpaid medical debt, including nursing home payments. Medicaid can recoup payments it made from the time your parent reached the age of 55 to the time of their death. The law of “filial responsibility” applies in 28 states. The shared property or monies of the decedent and beneficiaries the state can access to recoup Medicaid funds.
Tax Issues
The estate must pay property taxes and federal estate taxes before allocating assets. They will not likely owe personal income tax in the year of their death but check with your Certified Public Accountant (CPA) to understand filing needs.
Credit Card Debt
The estate must pay this unless you a cosigned for the credit card. In that case, you inherit the debt directly. Either way, credit card debt reduces your inheritance.
Personal Loan Debt
Personal loans also come out of the estate unless you cosigned for them. In the case of cosigning, you must re-pay the loan, but you may simply assume the payments and continue to re-pay it to the bank.
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Can You Inherit Debt from Your Spouse?
The same types of debt you could inherit from your parents, you can inherit from your spouse. This makes it imperative that both spouses understand the finances and remain cognizant of all bills due. You do not have to have a spouse die to realize this since many people learn this when they obtain a divorce.
When your spouse dies, you inherit the joint debts such as loans and credit cards you took out under both your names. You also inherit the taxes on the property. If your spouse’s debt is more than your assets and those of the estate, you will need additional money to pay it off. In a community property state, you share debt in marriage regardless of whether you both signed for it or only one party did so. The community property states are:
New Mexico
Texas
Washington
Wisconsin
The US territory of Puerto Rico.
Arizona
California
Idaho
Louisiana
Nevada
In Alaska, you can sign a community property agreement as a couple. Without the agreement, common law applies and the surviving spouse has no responsibility for the debt.
The exception is pre-marriage debt. The spouse who brought the debt into the marriage such as private student loans or credit card debt remains the sole responsible party until death. At that time, the estate must pay it off.
Can You Inherit Debt from Your Child?
All of the above types of loans, you can inherit from your child as well. If your adult child precedes you in death, you could inherit their debt except for their student loans. Technically, it will come out of the probate, but that reduces what you inherit, so you still paid it.
Student Loans and Death
Federal student loans and student loans that went through the parent get automatically forgiven when the student dies. A parental or PLUS loan also gets forgiven when either the parent or student dies.
The exception is if the parent cosigns for a loan regardless of the loan type, you remain on the hook for it. Cosigning means you assume half the risk for the loan and it equally belongs to you. In this case, when the student dies, the loan does not go away. If you cosigned for a student loan, it still exists after your child dies and you must assume the payments.
Can You Inherit Debt from Your Business Partner?
Yep, in a way. When a business partner dies, the bank can call up the business’ key loans. This applies to mortgages or notes, too. If you are unfamiliar with the term call up as it applies to loans, it means the bank can say that you must fully pay off the loan immediately.
That may sound freaky, but with business loans, you pitched the bank giving you the loan based upon the structure of your business, the financial capacity of its partners, its solvency, and perhaps collateral of one or both partners. You provided a business plan. When the partner dies, you no longer have that structure, collateral, and you have lost a portion of your financial capacity. The bank can call up the loan immediately since your risk level has changed radically.
When You Inherit a Business
Explaining business inheritance gets complicated. When you inherit a business, whether a corporation, limited liability company (LLC), or sole proprietorship, you inherit its assets, liabilities, stock, and its debt. There is no way around the latter. This is not true if you merely inherit stock in the business, but if your parent or child or partner actually leaves you the business, you own it all. You can sell it or run it.
Either way, you must continue to pay the debts while you shop it for sale or you run it. If your family business is a manufacturing plant, your parent leaving the company to you results in your owning it. If the business took out a loan for new equipment two months before the parent’s death, the business still owes that money.
You inherited the business and it still owes the money. You personally do not become liable for the loan repayment, but the business continues to be. It becomes your responsibility as company president to manage the business and ensure it pays its bills.
Can You Inherit More Debt Than Assets?
Yep to this, too. You can inherit more debt than assets. When the estate does not have enough assets to cover the debt, the probate court declares it insolvent. The court uses all of the assets to repay as much of the debt as possible. Any remaining debt usually gets written off.
If a loan used collateral, that bank or another creditor can seize the collateral when the death occurs if the assets in probate cannot completely repay the loan. The best way for the decedent’s heirs to keep the asset is to assume the loan payments.
The probate court follows state law in determining in which order a debt gets paid. Most states use a similar payment order:
Legal fees, including executor fees, attorney fees, and estate's taxes,
Funeral and burial costs,
Allowance for dependent family members,
Federal taxes,
Property taxes,
Medical bills not covered by insurance,
Unsecured personal debt.
How to Circumvent Issues with Estate Distribution
If you read our publications regularly, you know that you need a will and a trust to properly plan for your death and ensure that your assets get distributed properly. A living trust works best for you to retain ownership until your death while immediately transferring property to your heirs. Move as much real property and as many assets such as stocks and bonds into the trust as possible. You can continue to manage them yourself within the trust unless you create an irrevocable trust.
Many other financial tools also exist for disbursing money directly to beneficiaries, such as life insurance policies, retirement accounts, annuities. All of those options avoid probate. This means that the deceased could have an insolvent estate as far as probate is concerned, but their overall financial situation was solvent and they left assets to their heirs.
Open and Honest Discussions
Most families stress about money and debt. According to the American Psychological Association (APA), the topic of debt causes the most stress in the US. You can avoid falling into this category of people by planning ahead wisely.
The best way to avoid these problems is to engage in open and honest discussions about finances and debt before marriage and before your children reach the age at which they could take out credit cards or loans. Ask your future partner point-blank how much debt they have incurred and their repayment schedule. You should admit to any of your own debt as well. This lets you plan your debt repayment strategy together. It also ensures that you will not have any surprises after marriage.
Your children may not think about financial planning until they graduate college. Some will not seriously financial plan until their 30s. Some may plan but mess things up. It happens. No one is perfect, but you can give them a terrific head start on doing things the right way by having upfront conversations about finances and debt.
When they are kids, have them watch while you balance the checkbook or review the credit card statement. If you do buy something on credit, take them with you to pick it up and explain why you chose to buy it using a credit card instead of using layaway or saving for it. Explain why credit was the last option due to its interest rates. You can help your children understand loans early in life and prepare them for using them as a last resort. Saving for a purchase should always receive the biggest push.
You can also teach them early on the difference between unscrupulous financial messages, scams, and genuine messages from banks and credit cards. This ensures they start out savvy financially. Continuing education as they age so they enter college with a good handle on money management helps them avoid making money management mistakes.
Although it might seem weird, you need to talk to your parents about their debt. Once they age and you become an adult, the tables turn a bit and you must educate yourself about their finances.
Hold an open and honest conversation with them to make sure they are not drowning in debt. If you determine there may be problems after the conversation, you can ask them to go with you to meet with an estate planning lawyer. Ask them the following:
1. Do you have retirement savings?
2. Do you have a budget?
3. Do you have credit card debt?
4. Do you have a mortgage?
5. Do you have life insurance?
Finding this out while everyone can do something about it if some questions go badly. You can help your parents better plan for their golden years.
What to Do When Someone Dies
When your loved one dies, among the many tasks you have is to alert credit card companies and any lenders about the person’s death. As soon as you have it, mail them a certified copy of the death certificate. This stops interest accrual.
Stop harassing emails, phone calls, and other contacts from bill collectors by requesting proof of the debt. If they claim you are a cosigner on the account, ask for proof. Have them mail it to your attorney or the estate’s Executor.
Final thoughts
Thinking about a potential debt you may inherit is definitely something you should do, but more importantly, you should think about your own debt. Or how to avoid it altogether. With the right financial tools, you can stay out of debt, and if you already have debt, you will be able to pay it off.