WILLS, TRUSTS AND ESTATES NEWSLETTER
APRIL 4, 2017
How does Debt Impact an Estate Plan?

For various reasons ours is a debt-ridden culture. When creating an estate plan, sometimes people are more worried about the debt they might be leaving than the assets they might be leaving. What happens to a house if mortgage payments are behind and the homeowner dies? What happens to credit card debt when the debtor dies?

Leaving Homes with Little or No Equity

If a homeowner dies who is behind on mortgage payments, the person to whom the property is left does not have to accept the inheritance or the debt associated with the property. If the beneficiary cannot afford to make the mortgage payments or cannot afford the insurance and maintenance of property, the designated beneficiary may disclaim the property (not accept it). The property would then either be passed to the next person designated in the trust, or to the next person according to law who would be entitled to the receive it. If no one claims the property and if no one assumes the mortgage, the home would likely become the property of the bank as it would in foreclosure.
The best thing individuals can do is work to eliminate debt but if they can't eliminate it, they can make a plan to protect loved ones. Estate planning attorneys generally tell people it is beneficial to avoid the probate process but in the case where an individual has a lot of debt, probate may be a better process for closing the estate.

Settling Debt in Probate

In probate, creditors are notified of the death of the debtor and the creditors have a limited amount of time to make claims on the estate. The court then settles any disputes regarding debts and can help settle debts if there are not enough assets in the estate to pay all the debts. If there is outstanding credit card debt of $25,000 but there is only $15,000 of assets in the estate, then the court may help decide how much each creditor should get from the estate.

What is more, probate can help to get some of the estate's property to the family through the statutory fee scheme. An executor or estate administrator is entitled to fees based on the gross value of the estate (the value of assets regardless of debt). In particular, where a house is under water, the California Probate Code provides that the administrator of the estate and the attorney for the administrator get paid before the bank. Only the IRS and Franchise Tax Board have priority over the costs of administration where a house is worth less than the debt attached to that house. Thus, for example, if a house is worth $1M, the administrator and the attorney each receive $23,000 in fees before the bank gets paid out of a short sale. If the administrator/executor is a family member, the family member will at least receive something out of an otherwise indebted estate.

Settling Debts Outside of Probate can be More Difficult

If an estate does not go through probate, creditors have a longer amount of time to make claims on the estate and the estate does not have the comprehensive coordination to pay all the debts at one time, the personal representative may be left trying to manage assets for a long time and there may be no assets left to pay creditors. A personal representative is not personally responsible for settling debts of the estate. Only the assets in the estate may be used to settle the debts of the estate.
An experienced estate planning attorney can help you strategize to mitigate the negative impact of debt. And if you are a survivor of someone who held substantial debt, an experienced estate planning attorney may be able to help you negotiate settlement of debt (especially debt for medical treatment) for pennies on the dollar.

SIDE BAR

Some debts are forgiven when the debtor dies and some are not. When creating an estate plan, it is important to create an inventory of both debts and assets. If an estate must pay creditors before it can provide assets to beneficiaries, there may be a chance that there will be nothing left in the estate to give anyone. For example, if a house is underwater, it may not make sense to continue to make mortgage payments if other debt could be paid off which might come out of the estate. Many student loans are forgiven when the student dies so that may also be a debt which is paid after other debts when you cannot pay them all each month.

Gadi Zohar Intro Video
Gadi Zohar Intro Video