Using Life Insurance to Pay Off Debt
Your beneficiaries can use life insurance to pay off your debt, but not all debt is inherited.
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Paying down debt can be financially draining and stressful and not something you'd want your loved ones to take on after you die.
Many kinds of debt aren’t inherited by family members or cosigners. But for the debts that might be passed on, a life insurance policy can be a good option to help your loved ones cover the balance.
Here’s help to think through two key questions about using life insurance to pay off debt:
Will my debts be passed on if I die?
How could I use life insurance to help pay for debts that are passed on?
The primary purpose of life insurance is to replace your income after you die. So, aside from covering debt, you may need coverage if anyone relies on you financially. The payout can replace your salary and give your loved ones the cash they need to maintain their lifestyle.
What happens to your debts after you die?
In general, the assets in your estate are used to pay off your debts when you die. If there isn't enough money in the estate to settle the debt, it goes unpaid. However, there are circumstances where other people may be responsible for the remaining balance.
Cosigners and joint owners: If someone cosigns your debt, they're typically responsible for it after you die. Similarly, a joint owner of the debt is equally accountable for it. So if you or the joint owner die, the surviving member must pay off the balance.
Spouses: In community property states, surviving spouses are responsible for debts left by deceased partners. Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin are community property states. Alaska, South Dakota and Tennessee have elective community property rules. In some states, spouses may be responsible for certain debts like health care.
Even if no one is responsible for your debts after you die, you may still want coverage. A life insurance payout can help your beneficiaries pay off any outstanding debts so the money in your estate can go to your heirs. You can also use life insurance to leave a separate inheritance from your estate.
Using life insurance to cover debt
If you have debts that can pass on to loved ones after you die, a life insurance policy could help them pay off the balance. There are also life insurance products designed to pay off specific kinds of debt — but these aren’t right for everybody.
Here are some of the types of life insurance you might consider and how to tell whether they’re a good fit for your needs.
If you'd be responsible for someone else's debt if they died, you can buy life insurance on their life with their consent and put yourself as the beneficiary.
Term life insurance
Term life insurance is sufficient for most people and a common option for covering debt. These policies are designed to last for a set period, like 10 or 20 years.
If you die while the policy is active, your beneficiaries will receive the life insurance death benefit. So if you have debt with a certain term length, you could buy term life insurance to match the length of the loan. For example, if you have a 20-year mortgage, you can buy a 20-year term life policy.
Beneficiaries can spend a term life insurance death benefit as they see fit, so it can be a good, flexible option to cover any kind of debt.
Permanent life insurance
Unlike term life, permanent life insurance policies are open-ended and designed to last your entire life.
If you want your beneficiaries to receive the death benefit regardless of when you die, a permanent policy like whole life insurance may be a good fit. However, permanent policies are more expensive than term life policies, and you may not need lifelong coverage.
» MORE: Average life insurance rates
Mortgage protection insurance
Mortgage protection insurance is optional coverage lenders offer when you purchase a home. These policies pay off your mortgage if you die with a balance. The death benefit declines over time to match the outstanding sum you owe on your mortgage. The payout goes to the lender, not to your beneficiary.
For example, your lender might issue a policy that starts at $500,000 policy to cover your $500,000 mortgage. As you make mortgage payments, your life insurance face amount will decrease.
Term life insurance might be a better choice for most people because it’s often cheaper than mortgage protection insurance and doesn’t have declining coverage. And because the payout from a term life policy goes to your life insurance beneficiary, not your lender, it can be used for any purpose.
Credit life insurance
Credit life insurance is a type of coverage offered by lenders, but it isn't always the best or cheapest option. Mortgage protection insurance is one example of credit life insurance, but you could also get it for credit cards or other kinds of debt.
The death benefit in these policies decreases as the loan gets paid down, but your insurance premiums stay the same. The death benefit goes to the lender to settle the debt, not to your beneficiaries.
Term life insurance is generally a better option for those who qualify. To compare, term life pays out to your beneficiaries, not the lender. And the death benefit stays the same, so your beneficiaries receive the full amount if you die within the policy's term.
How much life insurance do you need to cover your debt?
Use our debt calculator to estimate how much life insurance you need.
If you have debt that generates interest, like a credit card, don't forget to factor in the added amount when calculating your coverage.
Covering large debts isn’t the only purpose for getting a policy. Here are other common reasons to buy life insurance.
Still not sure if you want to get life insurance to pay off debt when you die? Use our tool below.
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