What Happens to a Loan if the Borrower Dies?

When a loan borrower dies, the loan balance doesn’t die with him. Specific laws on the legal procedures the deceased’s lender must follow to either collect the loan or seize any collateral he owns vary by state. 

Co-signers and Joint Debtors

If the borrower had a co-signer, or joint debtor, on the loan with him, that individual becomes responsible for the full loan balance as soon as the borrower passes away. If the joint debtor or cosigner is unable to meet the loan obligations, the lender has the legal right to file a lawsuit in order to procure payment on the debt.

Should the lender win its lawsuit, it may garnish the debtor’s bank accounts or wages to recover the debt. Some states, however, only allow garnishment for government debts such as tax liens and child support. 

Secured Loan Recovery

If an individual dies while still owing money on a secured loan, such as a mortgage, the executor of the deceased’s will or his next of kin must inform the lender of the death and provide it with a copy of the deceased’s death certificate. Once the asset is assigned to a friend or family member by the executor, that individual is responsible for paying off the loan. 

If the deceased has no loved ones willing to take possession of the asset and the accompanying loan obligation, the lender has the right to seize the collateral due to nonpayment. A lender cannot, however, force the deceased’s next of kin to pay off the debt. 

Unsecured Loan Recovery

An unsecured loan has no collateral connected to the balance. Thus, if an individual stops making payments, the lender cannot seize any property as a result. When a debtor dies and leaves behind an unsecured loan, the lender may file a claim against his estate for repayment. If the debtor leaves behind assets, the executor of his will must use the assets to pay off the deceased’s creditors before allocating money and items according to the direction of the deceased’s will.

In some cases, an individual dies without leaving behind any assets that can be used to pay off unsecured debts. This means the estate is “insolvent,” and a lender can’t hope to recover any money. Some unethical lenders will attempt to collect the debt from family members or worse, sell the debt to collection agencies who will then harass the deceased’s loved ones for payment. Unless the deceased had a joint debtor or co-signer on the loan with him, however, no one is legally responsible for repaying his debt. In this scenario, the lender must write off the debt as a tax loss. 

Community Property States

Community property states deal with assets and debt differently than most states. In a community property state, the deceased’s spouse may be held liable for any debts the individual accrued while he was alive--even if her name does not appear within the loan paperwork. If the deceased was married and lived in a community property state, his spouse should visit with an attorney to evaluate her obligation, if any, to repay the balance of her spouse’s loans after his death.

Ref : www.loan.com