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One of the biggest misconceptions out there at the moment is that debts are written off if/when they die.
You might think that debts are no longer your concern if the worst happens to you, and you’d be right to an extent, but the financial situation you leave behind can have a serious impact on your family.
This is because creditors (the people or companies you owe money to) reserve the right to make a claim against your estate for any debts owed at the time of your death.
For someone who has no dependents and no assets (such as money or property) they’ll be nothing for the creditors to take from.
However, for a person with their own home it could mean that their loved ones can no longer afford to keep the property on.
To make this even more upsetting to your family, if any of your debts are held jointly, it will mean that the other person is now liable to pay 100 per cent of the remaining debt.
This includes the biggest debt you’ll probably ever have had in your life – your mortgage.
Take this example into account: Mr A is a solicitor earning £80,000 per year. His wife Mrs A is a housewife with no income. They have three young children.
Their property was purchased on a joint mortgage of 190,000 and their property is worth £300,000. (Despite the fact that Mrs A does not have an income of her own, she can still be party to a mortgage as her husband’s income covers it).
Unexpectedly, Mr A falls ill and sadly passes away.
In this circumstance Mrs A has the dual grief of losing her husband and now having to pay off a mortgage that she no longer has the money for.
So, as well as losing her husband Mrs A is now in a situation where she and the children are going to be homeless because they cannot cover the debt left behind.
At this stage it must be pointed out that debts are not passed onto your next of kin. The only time a person would be lumbered with your debts on death is if they held the debt with you on a joint basis like in the example above.
This doesn’t mean that debts go away though. In fact it can mean that your next of kin has a lengthy wait before they can take control of your assets.
On death the executor of your estate will work out the value of your assets and if the sum is greater than £5,000 then a process known as probate must be adhered to.
The probate office will set out the terms for how your assets will be distributed and the executor must obtain a grant from the office before they can start to look into financial areas such as bank or savings accounts.
The executor is allowed to withdraw money from the estate to pay for funeral costs. After which they must use the money to pay of secured debts, then unsecured debts before distributing the remaining sum to the person’s next of kin or to the person/persons set out in your will.
So, for example, you might think having £50,000 in the bank will leave your family with a nice living if the worst happens to you, if your debts (including mortgage) are £45,000, all they will actually be getting is £5,000.
A solution which many people overlook , particularly when taking out their mortgage, is how life assurance can alleviate these issues.
Life policies are paid into the estate so the money it can be used to clear the debt, speed up the probate process and leave your loved ones with one thing less to worry about.
In the case of Mr and Mrs A, their policy (if set up correctly to cover the mortgage value) would have meant that the mortgage is paid off and therefore Mrs A would have a property in her possession unencumbered (meaning without debt).
Great point of how life insurance is a great help in times like this. I’ve seen too many people run into a situation like this and either have no will or no life insurance. We have a policy that’s dedicated solely to paying off our mortgage if my wife or I were to die unexpectedly.
John S @ Frugal Rules recently posted..You Won’t Reach Retirement Without Saving for It
That’s something I’ll have to look into when I take on a mortgage…well if it’s purchased with someone else anyway. I’d hate to leave someone in that kind of situation.
I am quite glad debt is not passed down to next of kin. This is exactly why I won’t co sign for loans for anyone!
Brian recently posted..Updates: October 28 – November 3
I actually didn’t know that. I always assumed someone would still be on the hook for that debt.
“The executor is allowed to withdraw money from the estate to pay for funeral costs. After which they must use the money to pay of secured debts, then unsecured debts before distributing the remaining sum to the person’s next of kin or to the person/persons set out in your will.”
Interesting, I don’t know much about this area, so if you are given something in a will, such as a house that still has a mortgage on it, the executor will sell it and you get the remaining money after the costs unless you start paying the mortgage to keep the house?
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I can`t say I know much about the situation either. I would think you could take on the mortgage if you chose to, but I don`t know how it would work otherwise.
I’m often surprised as to how little people know about this. I’ve personally met with dozens of people that believe all of their debts are eliminated when they pass. While that can be true, it won’t be if you have any assets left in your name when you die (depending on the debt…student loans for instance do go away even if you have an estate).
Jason @ WorkSaveLive recently posted..Our Journey Out of Debt – October 2012
Interesting that student loans work that way. You`d think the government would still try to get its money, especially since they are not getting the potential tax income from that student that they essentially invested in.
Good example! I’ve known that this can happen for a long time, and it still frightens me how many people just assume that your debt disappears when you die. Yet another example of why life insurance is so incredibly important!
My Money Design recently posted..My Money Design for Achieving Financial Freedom – November 2012 Update
I never really knew exactly how it works either. I wonder if the rules are the same in Canada or the US. It does make sense that assets would go towards paying off debt.
Great article today. I’m actually in the process of building a new house right now and it will end up being the biggest debt I’ve ever had to carry. However for me I don’t carry any other debt and I have a decent size life insurance policy to boot.
Sounds like you`re covering your bases while taking on that big debt. Building your own house must be pretty exciting though.
Interesting story, it makes sense to talk to your spouse and probably an adviser to see how to spread debt and protect your family. I have a friend whose parents never married, all the debt is on her dad’s name and her mum owns the assets.
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I don’t think that strategy would work to protect each other from debt here in Canada. They’d be considered common law and the courts would treat them as a married couple.
Yes, life assurance is a must if you have a family at all. My brother and his wife (he works, she is a stay at home Mom) have enough to be sure that if anything happens to either of them, the remaining one and their child will be okay.
Cat recently posted..Why it’s very important to factor in long term costs for a house
Yes for families it is quite important. For now while I’m single though, there’s not much point in paying for it.
Very interesting topic. I know you are required to put a notice in the local newspaper about someone’s passing asking all creditors to claim debts against the estate. What happens if someone doesn’t come forward during the probate period? Are you still required to pay the debt if no one knows about it? I guess we all just need to have lots of life insurance if we have debt.
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I didn’t know it was a requirement to post a notice in the local newspaper. I’m not sure what happens with debts that nobody knows about. I think it would be kinda tough to prove it even existed. I know there are scammers out there who pretend they are owed debts from people who pass away.
None of my creditors even know I am married, and the mortgage is paid with my wife’s income, so I’m not concerned at this time about life insurance.
It sounds really dumb, but make sure that if you leave something like a house to someone and you owe money on it, make sure that person knows. I know a woman who was inherited a house from her mother, but didn’t know that there was a small 2nd mortgage left on it. She never made a single payment and the house was forclosed over a $5,000 debt.
Ouch that sounds like a shitty situation for a house to foreclose over such a small amount. I think in that case the bank really should step up and notify the new owner. Perhaps they never found out about the death though.
As long as your wife can afford to pay off the mortgage and cover a potential funeral, I guess it might be ok to skip life insurance. I’d think it would make things pretty tough for her though.
We both have life insurance although our house will be paid off this year (well that’s the plan). We have plenty of friends who have no life insurance and have children and I know exactly what could happen. With more and more mums staying home now to watch the kids it becomes a must.. You have to look after your own first. Mr.CBB
Canadian Budget Binder recently posted..October 2012 Canadian Budget Binder Family Budget Update
It’s a little scary to think of the risks that some people take when it comes to life insurance. They all think the worst would never happen, but boy will someone regret it when it does happen.
I agree life insurance is very important to have. It can even be important to people who actually manage to save enough money to get hit by the estate tax. Since life insurance proceeds are considered tax free you can use them to pay the bill for estate taxes. Of course most of us probably won’t be in the situation where we will have to pay an estate tax (I believe you have to have more than $5M in assets presently) but we can all dream that we might one day have that much!
lol I wouldn’t be worried about potentially having $5M in assets. If I did, I wouldn’t have a problem paying some tax on that money. I guess the rich stay rich by smart moves like taking advantage of tax loopholes though.
Honestly? Suck. Suckage. Major suckage. It makes sense, I mean, people handing out loans should get something back no matter if someone dies or not. But it might be nice if their greedy little hands had to wait a year or something. Let the grievers have their freaking time!
Good point. There should be some kind of grievance period since it can take some time for everything else to get sorted out. Companies do deserve to get their money eventually though.
So basically one can avoid getting insurance as soon as the mortgage is paid off. What’s left to protect for if your biggest debt is paid?
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I guess in some cases that very well could be true. It depends on what your family would need to get by if you were to pass away though. They might still be relying on your income for stuff like retirement savings and putting kids through college.