Resolving Debts in a Will
One of the duties of the person administering an estate is to pay the debts of the decedent. Before an estate is distributed, the legitimate debts must be ascertained and paid.
An exception is secured debts. These are debts that are protected by a lien against property, like a home loan or a car loan. In the case of a secured debt, the loan does not have to be paid before the property is distributed and if a piece of property is collateral for a secured debt, that property can be distributed, but the debt will go with it.
Example: John owns a $300,000 house with a $250,000 mortgage and he has $300,000 in the bank. If he leaves the house to his brother and the bank account to his sister, his brother would get the home but would owe the $250,000 mortgage.
What Happens if You Owe More than You Own?
Example: Jeb's will leaves all of his property to his three children. At the time of his death, Jeb has $30,000 in medical bills and $11,000 in credit card debt, and his only assets are his car and $5,000 in stock. The car and stock would be sold, and the funeral bill and probate fees paid out of the proceeds. If any money was left, it would go to the creditors, and nothing would be left for the children. However, the children would not have to pay the balances on the medical bills or credit card debt.
In many states, the creditors of a deceased person can only make claims against property that goes through probate. This means that if a person sets up his or her property so that it all avoids probate, any debts remaining at his or her death will not have to be paid.
Example: When Chris died, he owned a $200,000 house with his wife, a $25,000 bank account with his wife, a ranch worth $500,000 owned jointly with his brother, and $20,000 in stock in trust for his children. His debts were $5,000 on a personal credit card and a $20,000 line of credit in his name alone. Because all of his property will pass to people without a probate, in many states, his debts will not have to be paid, and the heirs will get the property free and clear.
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.
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.