Inheriting Debt: How Your Parents’ Credit Can Affect You
Financially, senior citizens aren’t doing so hot. The average debt among people 65 and older rose 83% between 2001 and 2010–much of it thanks to mortgages. Outstanding balances, of course, have consequences not only for the indebted individual, but for the family and heirs as well. When a parent passes away, the children are left to wade through the financial wreckage.
Do we inherit our parents’ debt? What precautions can we take? How do we protect ourselves from collectors? This article discusses debt inheritance and how to best prepare for the death of an indebted parent.
Is it possible to inherit debt?
Take a sigh of relief. By and large, the answer is no. For the most part, debts die with the individual. However, debts can annihilate inheritances, and there are a couple exceptions to the rule.
When a person dies, the executor sells off the deceased’s assets to pay off as many debts as possible. Payments are made in the following order:
- Secured debts
- Unsecured debts
- Inheritances as defined by the will
When a debt is “secured,” it has physical collateral that guarantees the balance. These are debts like mortgages and car loans. Unsecured debts don’t have physical collateral. The most common example is credit card debt.
Only once all debts have been subtracted from the estate do the heirs get their inheritance. If the estate’s assets are not enough to pay off the debts, the creditors take a loss, and nobody is legally bound to pay the debts.
Here are a few of the major debts and how they are handled after a death:
- Mortgages. When a parent leaves behind a mortgage, there are several options. If the estate has enough funds, they can be used to pay off the mortgage, allowing the heirs to take possession of the home. Alternatively, an heir may choose to take over the mortgage and the property, continuing to make normal payments. The heir can also refinance or sell the house to pay off the sum.
- Car loans. The options are pretty much the same as with mortgages. You can pay off the loan with funds from the estate, transfer the loan to your name, refinance or sell the car.
- Personal loans and credit cards. These debts must be repaid with money from the estate if possible. If there are not enough assets, the money is divided between debtors and the remaining balance is written off as a loss.
- Student loans. When a person dies, federally insured student loans are forgiven. Private loans are not and will need to be repaid the same way as personal loans.
Situations where you CAN inherit debt
Though we’re usually protected from inheriting debt, there are a few instances when we will be held legally responsible for paying off money owed:
- Cosigners will assume full responsibility of shared loans and credit cards. Be careful when you cosign.
- Joint account holders whose income and credit history were used to acquire a loan or credit card will be solely responsible for paying joint debts.
- Widows and widowers living in a “community property” state will be held responsible for their deceased spouse’s debts. These states are Alaska, Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin.
Avoiding sticky situations
The first step is the hardest. Talking to your parents or children about death and debt can be difficult, but it must be done. Make sure there is a solid estate plan in place; consult a professional if necessary. You may want to open an Irrevocable Trust, which removes all original rights of ownership to the assets and guarantees the trust to the beneficiary. Simply gifting away all assets before death doesn’t always work because creditors have the right to seize property transferred for the sole purpose of avoiding creditors.
Whatever the circumstances, know your rights. Debt collectors can be ruthless and persistent even when you’re under no legal obligation to pay off the remaining sum. Don’t feel bad about hanging up on collectors and writing a letter of to the agency if phone calls persist. If you feel you are being harassed, don’t hesitate to file a complaint with the FTC.