If you die any debts you have are paid off by money or property you have left behind. The remaining assets are given to the beneficiaries nominated in your Will. The question of how and when debts are repaid on your death is complex.
What happens to your debts depends on whether:
there are any assets in your estate
the debts are secured or unsecured
the debts are only in your name or in joint names with another person
someone has guaranteed the debts.
Expenses must be paid before the estate can distribute to beneficiaries
Generally, if you die your debt whether a home loan, personal loans, credit card debt or car loans must be paid back. Other expenses that must be paid before your estate can be distributed to your beneficiaries include funeral and testamentary liabilities. If there is insufficient money in your estate other assets such as any real estate may need to be sold and the proceeds of sale used to pay the debts.
Who is responsible to make sure my debts are paid?
The executor you have appointed in your Will determines what debts must be repaid. If there is enough money in your estate the executor will pay off the debts owed to your creditors using that money. If there is not enough money in your estate your executor may sell property and use the money from the sale to pay the debts. If there is not enough money in the estate after all the assets are sold, the debts may not need to be paid if the debts are unsecured debts in your name only and there is no guarantor.
Exception to the general rule to pay off debts using estate assets
a) Superannuation death benefits
Superannuation death benefits paid to your estate will rarely become available for the repayment of debts. Therefore, even if there are insufficient assets in your estate to pay off your debts, other than superannuation death benefits, such death benefits will not be available to meet the debts unless the Will expressly specifies to the contrary.
b) Life insurance payout
Under ss 204 and 205 of the Life Insurance Act 1995 (Cth) and subject to the Bankruptcy Act 1966 (Cth):
the rights and interests of a person under a life policy effected on the person's life or the life of the person's spouse or de facto partner are not available for discharge of the person's debts and
if, on the death of a person, money becomes payable to a person's estate under a policy effected on the person's life, that money is not available for payment of the person's debts, unless the person had entered into a contract that provided expressly for the money to be so applied or had charged the money with payment of the debt, or gave an express testamentary direction signed by the person that the money be so applied.
Therefore your life insurance payout will not be available to meet your debts unless the Will expressly specifies to the contrary.
c) Debt relates to a specific gift under your Will
If a debt is secured by an asset gifted in your Will, unless otherwise specified in your Will, the debt will follow the asset. If you leave your family home to a nominated beneficiary in your Will then any loan secured by that property will follow the gift. If your nominated beneficiary cannot afford to absorb the debt by paying it or transferring the mortgage into their name the property must be sold, the loan repaid, and the balance distributed to your nominated beneficiary.
To illustrate the risk here is a short case study:
You have 2 properties and you have left 1 property to each of your children assuming you have provided for them equally as each property is worth $600,000. However, you have not considered the loan of $300,000 you still must pay back to the bank for one property.
The result is that if you die one of your children will inherit a property worth $600,000 and the other child will inherit a property worth $600,000 with a debt of $300,000. This is not what you intended and is likely to cause friction between your children. Potentially, one may even start a claim for a better provision in the Supreme Court of Western Australia.
This case scenario may become even more complex if one of your properties was your principal place of residence and the other was an investment property. Capital gains tax liabilities on an investment property could be substantial and may affect the net after tax value of the asset being transferred significantly.
Understanding secured and unsecured debts
Secured Debts
A secured debt is a debt secured against one of your assets. If you have borrowed money the lender may have taken security for the debt. To recover the debt the lender also known as a creditor may sell the asset to recover the debt. A home loan and a car loan are examples of a secured debt.
Unsecured Debts
An unsecured debt is when the lender has not taken security for the debt. Hence there is no asset the lender can sell to recover the debt. The lender must go to court and get an order to take your assets and sell them to pay off the debt. Credit card debt and personal loans are examples of unsecured debts.
Secured creditors will have rights against the security in priority to unsecured creditors. If there are no sufficient assets to pay the unsecured creditors and such creditors are of the same standing, then the available assets are to be distributed to the creditors proportionally to the size of the amount owed.
What happens with secured debts such as home loans?
If you had an outstanding loan secured against a property owned by you, the lender can sell that property if repayments on the loan stop. While the executor and beneficiaries of your estate are not responsible for the debt, the estate may lose the asset if the loan can’t be repaid.
Your executor will usually use assets in your estate to pay off the home loan. See the paragraph Debt relates to a specific gift under your Will for exceptions to the rule.
If there is insufficient assets to pay off the outstanding loan one or more beneficiaries may chose to keep the property by paying off the loan or taking on the liability with the consent of the lender.
If your estate cannot pay off the loan and the beneficiaries cannot afford to keep the property and pay off the liability, the executor can sell the property, pay off the debt using the proceeds of the sale and distribute the balance under your Will.
What happens with unsecured debts such as credit cards?
Debts on credit cards are unsecured debts because the money borrowed isn’t secured by an asset. If you die the bank may use assets in your estate, money or property, to pay off the remaining credit card debt in your name.
If there aren’t enough assets in your estate to repay the credit card debt in full, the amount owing may be written off as a loss by the lender or sometimes may be covered by credit card insurance.
Having a credit card with another person as an “authorised user” does not mean there is a joint debt – one person can have the account and issue the other a secondary card.
When do other people become responsible for my debts?
a) Secured or unsecured debts in joint names
If you have a secured or unsecured debt in joint names, then all borrowers named on the account are responsible for the debt jointly and severally. If you die the surviving joint account holders will be responsible for the whole debt.
b) Home loan
in joint names
A common example of a jointly held debt are home loans taken out by a couple. If you die your surviving spouse will be solely responsible for the remaining loan.
c) Credit cards in joint names
Only a few credit card providers in Australia allow you to apply for a joint credit card with your partner or a family member. If you die the other joint credit card account holder will be liable to pay the credit card debt.
d) A guarantor for my debt
A guarantee is a promise to continue repayments if the borrower stops making them. If a friend or family member has acted as a guarantor for your loan, the lender can chase that person for the debt if you die.
e) The debt is secured against an asset owned by someone else
If the debt is secured by an asset owned by someone else, the lender can sell the asset to repay the debt.
Debts unable to be repaid
The executor will let the lenders know that the debts will not be repaid. The executor will check if there are any assets available to creditors to repay the debts. Other family members and beneficiaries need not do anything.
Will any debt be payable by my executor, spouse, beneficiaries or family members?
Other people are only responsible for repaying your debts after you die if:
The debt is in joint names with someone else such as a home loan with your spouse
The debt is secured against an asset owned by someone else, such as a husband and wife’s joint loan, secured against a property owned by the surviving spouse
Someone has guaranteed the debt.
Lessons learned
To create as little hassle as possible for your loved ones sign a valid Will. Ensure that the executor will take on the responsibility.
Make sure that your Will is regularly updated and that your wishes are clear. Discuss any outstanding debts with your lawyer so the management of such debts is clearly set out in your Will.
You will be doing your beneficiaries and executors a favour if you seek legal advice about your Will and estate planning. Contact us for a free will assessment which includes a comprehensive analysis of your situation and a thorough breakdown of what needs to be done to help protect your family, assets and minimise tax.