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What happens to debt when you die or become disabled?

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A 2019 study conducted by Experian found total consumer debt in the U.S. exceeded $10 trillion, with Americans carrying an average personal debt of over $90,000. Many people are under tremendous stress taking this amount of debt on, working each day to make progress in paying outstanding loans off.

But what about the twin catastrophic events of death and disability? How do they affect debt? What are your financial obligations, and how do they affect your family members?

In this article, we’ll examine the effects of death and disability concerning credit cards, student loans, mortgage loans, auto loans, and medical bills. To minimize the financial burden these events will have on you and your family; we need to understand what your obligations will be when the unexpected happens.

Credit card debt

Unfortunately, your obligations for credit card debt you’ve created do not end in the event of death or disability. Your creditors lent the money in good faith and are expecting repayment in full.

If you pass away with existing credit card debt, existing assets can be used by your estate to pay off that debt. Cash available from your accounts can be used, or other assets can be liquidated, such as an investment portfolio. In cases of extremely high credit card debt, selling a residence to pay creditors may be necessary. Your heirs will have to contend with the credit card companies and make suitable arrangements.

Many people are under the false assumption that if you become disabled and have credit card debt, you are no longer responsible for repayment, which is not the case. You are still responsible for making the required monthly payment per your contract with the card issuer. If you stop making payments, penalties and interest will accrue, and if you end up in court for non-payment, you’ll be faced with legal bills as well. Your credit score will also suffer.

Some creditors will work with you to help minimize the financial burden that disability has placed on you, like lowering the interest rate or the minimum monthly payment amount. However, this is a short-term solution to what may very well develop into a long-term problem.

[ Related: 5 expert tips for improving your credit score ]

Student loan debt

When someone dies that has debt from a federal student loan, that debt is fully forgiven and does not need to be repaid by anyone. However, a private student loan still must be reimbursed by the estate of the deceased and may result in the necessity for assets to be sold to pay back the lender in full.

In the event of disability, many people carrying student loan debt will seek a Total and Permanent Disability (TPD) discharge. By definition, the borrower must be permanently disabled and, as a result, unable to perform their regular occupational duties.

Obtaining a TPD discharge is much easier said than done. Veterans must meet the definition of being disabled on an individual unemployability rating, and non-veterans must qualify by meeting the criteria of the Social Security Administration to receive Social Security Disability Insurance (SSDI) benefits. Achieving either of these criteria and qualifying for a TPD discharge is very difficult to do.

In the event of a partial and non-permanent disability, repaying outstanding student loan debt is still your responsibility. If you are unable to meet your obligations, you may end up defaulting on the loan, which will result in costly penalties and interest, and adversely affect your credit rating.

Mortgage loan debt

In the event of the death of someone that has a mortgage on a home or property, that mortgage amount still must be paid back to the lender. A joint owner or the person that inherits the property will be responsible for maintaining payments, and if they are unable or unwilling to do that, the home will need to be sold. The effect on survivors can be devastating.

When a disability occurs, and there is mortgage debt, repayment becomes very difficult. For most people, the mortgage is the most significant financial liability they carry and can consume as much as 25% or more of their income. There are some programs to assist disabled individuals with mortgage payments; however, they mainly offer partial assistance, while the full payment amount is due each month.

[ Related: What is disability insurance & how does it work? ]

Auto loan debt

If you pass away with an existing auto loan under your name, your estate will be responsible for continuing repayment. They can do this by making the required monthly payments or paying off the loan in full.

A disability does not absolve a borrower from their financial responsibility when it comes to auto loans. It doesn’t hurt to approach the lender and request a lower interest rate, payment forgiveness, or refinancing; however, the lender is under no obligation to accommodate you, and you’ll have continuous pressure to make your car payment.

Medical debt

When someone passes away, unpaid medical bills must be paid. It is the responsibility of the executor of the estate to pay these bills by using liquid assets such as cash, liquidating assets like a home, or using life insurance proceeds.

If you become disabled and can’t work, the medical bills will still keep on coming in the mail and must be repaid. If you can’t meet all of your financial obligations because of the disability and aren’t able to pay these bills, they will most likely be sold to debt collection companies, which are notorious for aggressively attempting to collect payment.

[ Related: How to get rid of medical debt ]

Financial protection for outstanding debt

As has been detailed above, our obligations to repay our creditors don’t vanish if we die or become disabled. Hopefully, we have sufficient cash on hand to pay these debts without placing undue strain on household or estate finances. In many cases, assets must be sold at a discount to generate sufficient funds to fulfill our responsibilities. However, having the proper amount of insurance coverage can help alleviate stress and provide the necessary funds to pay off creditors.

Life insurance policies provide much-needed money in the event of our death to pay our debts in full and alleviate the pressure our survivors will live with if we don’t provide the funds they need to pay existing loans. Many times we can apply for life insurance at the time we apply for a mortgage or auto loan for the sole purpose of paying off this debt if we die with an outstanding balance.

Anyone with outstanding debt needs to buy disability insurance. If we are home-bound or confined to a hospital bed, our creditors will still be looking to us each month for payment. We need a monthly income to meet our obligations, and a disability policy will provide us with a check each month to make the required payments. By paying the insurance company for a disability policy, we are, in effect, paying each of our creditors at the same time.

Proper preparation and forethought are our best defenses against the twin calamities of death and disability. By consulting with a licensed insurance agent today, we can prepare for the unexpected and protect our loved ones in the future.

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The information and content provided herein is for educational purposes only, and should not be considered legal, tax, investment, or financial advice, recommendation, or endorsement. Breeze does not guarantee the accuracy, completeness, reliability or usefulness of any testimonials, opinions, advice, product or service offers, or other information provided here by third parties. Individuals are encouraged to seek advice from their own tax or legal counsel.

— Published May 5, 2020
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