After a person dies, his or her property is used first to pay probate and funeral expenses and then to pay debts. Generally, all debts must first be paid before any assets are distributed. For instance, your outstanding credit card debts will be paid before any gifts are distributed to your beneficiaries.
Can a Will Distribute Secured Debts?
An exception to this general rule is made for "secured debts;" that is, debts that allow the lender to take possession of a specific piece of property if the debt is not repaid. Examples of secured debts are home loans or auto loans. If a piece of property is collateral for a secured debt, that property can be distributed, but the debt will go with it. For instance, say you have a car worth $10,000 and a loan on the car of $5,000, you can leave the car to someone in your last will, but it will be that person's obligation to pay off the loan.
What Happens if You Owe More than You Own?
In general, people cannot inherit another person's debts. If there is not enough cash in the estate to pay debts, all of the estate property will be sold to pay the debts. No one will inherit anything. For example, if someone dies owing $12,000 in credit card debt but has cash and property worth only $10,000, the property will be sold and the $10,000 will be paid to the credit card issuer.
You can imagine a situation where some property is sold to pay off debts but there are assets left to distribute. This can lead to some difficult decisions. The executor that you name in your last will must decide which pieces of property will be sold. The LegalZoom Last Will and Testament contains a clause that directs your personal representative to pay all debts and obligations as soon as practical, including any estate and gift taxes.
Receiving and Forgiving Debts in a Will
What if someone owes you money? This money will be collected and added to your overall estate. However, you can always choose to forgive a debt in your last will. This is similar in principle to granting a specific gift, but instead of leaving property, you provide forgiveness of a specific debt.