How Life Insurance Protects Your Family Against Debt

Posted by Matthew Cooper on Monday, February 24th, 2020 at 11:14am.

When you got married or had kids, you probably had dreams about all of the things you were going to provide to your family. We’re talking about that house with the white picket fence, those annual vacations under the sun, and even the pricey tech toys every other kid at school already has.

But you know as well as we do that giving your family a great quality of life costs money. And unfortunately, money doesn’t grow on trees. So you probably have a mortgage to cover your home, credit cards to pay for daily expenses, and maybe even a loan for your car. 

And for this reason, there’s something you may be wondering: “What happens to all of this debt when I die?” 

After all, when you’re working hard to give your family the best life possible, the last thing you want to do is burden them with debt if you were to pass away early. 

So what actually happens to your debt when you die? And how can you shield your family from it?

Keep reading because we’re breaking it all down below!

What happens to debt when you die?

All this talk about death and debt may be stressing you out, so let’s start off with some good news: in most cases, your family doesn’t automatically inherit your debt when you die. Phew!

You see, when you die, your debts get passed on to your estate. And it’s the funds that make up your estate that get used to pay off your debts. 

If your estate is worth more than your debts, your estate will be used to pay off all the debts, and any money that’s left over will go to your heirs. If your debts are worth more than your estate, all of the money in your estate will be used to pay off the portion of debts it can cover. There won’t be any money left over for your heirs, but they also won’t be on the hook for any outstanding debt that your estate wasn’t able to cover.  

For example, if you have a credit card and you’re the sole account holder for that card, your spouse and kids can’t be held responsible for any unpaid bills after you die. Even if they use your credit card for weekly shopping sprees, they won’t inherit your credit card debt as long as you’re the only account holder. 

Now, if someone inherits property from you and that property is associated with debt—a home with a mortgage or a car with a loan—they’ll become responsible for that debt. They’ll have to either take over the mortgage or loan payments or sell the property to pay off the debt. Of course, if they don’t have the funds to cover the cost of the payments, selling the property will be their only option.  

When someone else is responsible for your debt

Although other people usually don’t inherit your debt when you die, there are some exceptions to this. (We knew you were waiting for these!)

One exception is when someone co-signs a loan with you. In this case, the co-signer can be held liable for any outstanding debt related to this loan when you die. 

The other common exception is if you have a joint credit card account with someone. If you and your spouse, for example, have a joint credit card account, your spouse can be held liable for any outstanding credit card debt. This applies even if you were the primary spender on the credit card account and your spouse had access to it just for emergencies.  

How life insurance can protect your heirs from debt

In an ideal world, you’ll live well into your 80s or even your 90s, and you’ll die debt-free. That’s the dream! 

But sometimes life has something else in store for you and your family and you end up dying earlier than expected. Or sometimes you live a relatively long life but you find yourself still making mortgage payments into your 70s. (Seriously—lingering mortgage debt is more common than you’d think!) In these cases, it’s much more likely that your spouse or kids will inherit debt from an outstanding mortgage or car loan.  

The good news is that there’s a way to protect your family and heirs from this kind of debt: buying life insurance. 

When you take out a mortgage or car loan, your lender may try to convince you to buy mortgage life insurance or another type of credit life insurance. These are forms of insurance that protect your family from the debt of an outstanding mortgage or loan by ensuring that there will be money to pay off the debt when you die.

However, with these forms of insurance, the amount that would be paid out if you were to die decreases as your mortgage or loan balance decreases. But your premiums won’t decrease, so the insurance won’t become cheaper for you over time. 

The other big drawback of mortgage life insurance and other types of credit life insurance is that the beneficiary is the lender, not your family. 

That’s why we typically recommend using term life insurance to protect your family against your debts. 

Why term life insurance is the best way to protect your heirs from debt

Term life insurance is a type of life insurance that pays out a death benefit to your beneficiary if you die during the term of your policy. This term can be 10 years, 20 years, or more depending on your needs. 

With term life insurance, you can choose a coverage amount and policy length that matches the amount of debt you have and the number of years you expect to have it for. This means that you can pay for insurance only during the years when you really need it—usually when you have financially dependent kids and a mortgage. 

But there are other advantages of term life insurance too. Unlike with mortgage life insurance and other types of credit life insurance, the payout amount for term life insurance doesn’t decrease over time, you can designate a beneficiary of your choice, and the beneficiary can use the money in any way they choose. You also won’t have to get a new policy if you switch banks. And trust us, that’s a headache you want to avoid!

So in sum, if you die earlier than expected but you have a term life insurance policy that covers the cost of your mortgage, your family can choose what they want to do with the money. They can use the money to take over the mortgage payments so they can remain in the home and maintain their lifestyle. Or if they’re able to cover the mortgage payments on their own, they can use the money for other expenses, such as university tuition. 

In either case, they won’t have to deal with the financial burden of debt when they’re already coping with the emotional toll of losing someone they love. 

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