What happens to debt when a person dies?

Debt doesn't just disappear when a person dies. Debts must be paid by the estate or, sometimes, by those left behind. Read on to learn more about what happens to debt when a person dies.
What happens to debt when a person dies?

Life is complicated and we don’t always achieve what we set out to do. This can be especially true when it comes to debt. Unfortunately, not everyone is in the position to pay off their debts before they die. So what happens to these unpaid debts once we pass? Do they simply disappear or do they get passed on to our loved ones? 

Debt doesn’t disappear

The simple answer is no, debt does not disappear when someone passes away. However, the way in which debt is managed varies enormously according to the type of debt they have, the size of that debt, and the assets they owned at the time of their passing.

Debts must be paid before the estate is distributed

Put simply, when a loved one passes away their debts must be paid before their estate can be distributed amongst the nominated beneficiaries. This process is handled by the appointed executor of the estate. It is their responsibility to check whether there are any assets which can be used to repay any outstanding debts.

If there is enough money in the estate, the executor must pay the debts owed using that money. If not, the executor will need to liquidate (or sell) the estate’s assets and then use the proceeds to pay off the debts.

If there is still insufficient funds after all the assets are sold, the debts may not need to be paid. However, this really depends on the kind of debt that remains

Secured vs unsecured debt

There are 2 main types of debt - secured and unsecured debt. The main difference between secured and unsecured debt is the presence of collateral to support the loan.

Secured Debt

Secured debt is supported by an asset that may need to be sold in order to repay it. Examples of secured debt include, but are not limited to, car or home loans. In both these cases, the asset, namely the car and property can be sold to repay the remainder of the loan and mortgage.

Unsecured Debt

Unsecured debt on the other hand refers to debt which is not tied to an asset. Examples of unsecured debt include credit card debt, personal loans, medical bills and utility bills.

Which debts are paid first?

Before an estate can be distributed to nominated beneficiaries, any debts must be paid.  But which debt is paid first? Well, as you might expect, any outstanding tax is the first bill to be paid and it must be paid in full. In the case that an outstanding tax bill consumes the entire estate, then that’s it - your loved ones won’t receive any of the inheritance you planned for them.

In addition to tax, funeral fees and estate administration expenses can also be paid before other liabilities. After that all the remaining outstanding debts are arranged according to priority. Typically, unsecured debts are deemed less important so they fall to the bottom of the list.

What happens when an estate is insolvent?

If an estate has insufficient funds to repay the outstanding debts, it is declared insolvent and remaining debts are written off. The executor is responsible for informing the creditors that they won’t be paid and applying for bankruptcy on behalf of the estate.

Can debt be inherited?

Generally speaking, debt cannot be inherited by family members. However, there are a few exceptions to this rule. For example, when a family member

  • personally guarantees a deceased person's debt,
  • is a joint borrower, or
  • has an asset which has been used as security for a loan.

In each of these cases, the debt may be inherited and may need to be paid off. So it’s important to consider the ramifications of acting as a guarantor or agreeing to a joint loan.

Where can you go for help?

If you or a loved one are concerned about debt, you can seek support from the National Debt Helpline on 1800 007 007. The NDH is a not-for-profit service that can help people tackle their problems with debt. It’s a free, independent and confidential service.

Wrap Up

Debts accumulated in life must be repaid either during the person’s lifetime or after their death. When planning your estate and writing your Will, it’s best to create a list of your assets and liabilities in order to make the administration of your estate much easier for those left behind.

Write your Will online at willed.com.au.

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