Defaulting is the inability or failure to pay the interest on an existing loan when due. A personal loan when someone dies cannot be defaulted and is either paid through the deceased person’s estate or passed down to dependents in certain cases. In the United States, being late on loan repayment, defaulting, or missing a payment, can knock as much as 100 points off your credit score. This drop and its effects may persist in your credit report for up to 7 years depending on the terms of your loan. That’s why it’s important to ensure that you can afford a personal loan before you apply. Before we dive into what happens to personal loans when a borrower dies, let’s review the consequences associated with late repayments, defaulting, or missing a payment.
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What Happens if You’re Late on a Loan Payment
When borrowers take out a loan, lenders rely largely on trust to make the relationship work. When evaluating a borrower’s creditworthiness, banks and lenders consider payment history before approving you for credit. A long history of timely payments shows that you are a low-risk borrower and a suitable candidate for a loan, while a record of poor repayment can affect your ability to secure loans in the future:
- You May Pay Higher Interest Rates: Late loan repayments may result in higher interest rates, often caused by creditors subjecting your interest rate to a penalty APR, which can increase your payments.
- It May Show Up On Your Credit Report: A late repayment will only show up in your credit report if it is more than 30 days overdue, but just one delayed payment is enough to drastically reduce a good credit score rating. The three main credit bureaus in the United States have to be notified when a borrower fails to make loan repayments 30 days from the due date. However, a 30-day delay is bad but not as bad as a 60- or 90-day delay, so the sooner you catch up the faster your credit score can start improving.
- You May Incur a Late Fee: Failing to make loan payments by the due date can attract late fee charges to your existing loan. Late fees vary by lender and depend on the type of loan, your outstanding balance, and how late the payment is.
Defaulting or Not Paying Back a Loan in the United States
While being late on a loan can cause problems, defaulting on a loan is expensive, does serious damage to your credit score, and takes time to recover from. A personal loan is considered to be in default if the borrower has missed several repayments dates over a specified period in the loan agreement. Besides labeling you as not creditworthy, defaulting on a loan also has the following consequences:
- You Face Aggressive Third Party Collection Agents: Banks eventually turn defaulted loans over to a loan collection agency. While your lender was probably subtle in their approach—making calls and sending request letters for payment—collection agencies are more aggressive when pursuing payment from borrowers.
- Collateral Can Be Repossessed: When a borrower’s loan is backed by collateral such as a car, lenders can seize the car as a repayment for the defaulted loan. The time frame for a collateral repossession varies by state and depends on the loan agreement terms.
- Banks Can Access Your Money: When you owe your bank money and don’t pay it back, they can seize any money you have in a checking or savings account. This is referred to as the lender’s “right to set off” because the bank uses your money to offset your defaulted loan.
What Happens to Personal Loans When the Borrower Dies?
In some cases, a personal loan when someone dies cannot be simply written off and there are procedures that lenders and borrowers must follow when such scenarios occur. A deceased person’s estate is generally used by an administrator or executor to settle any unpaid debts he/she might have left behind. An estate includes cash plus everything of value that belonged to the deceased. If the estate can’t cover the debts, then it is considered insolvent and assets are sold to pay off debts. Whether you are legally obligated to repay a person’s loan upon their death depends on the type of loan, your relationship to the deceased, and other factors that we’ll outline here.
Loans are considered either secured or unsecured debt. A secured loan is tied to a form of collateral such as a car or house. Unsecured debts include credit cards, personal loans without collateral, student loans, and utility bills to name a few. If there was a co-signer on a personal loan, then the co-signer is responsible for the balance of the amount still owed when someone dies. If there is no co-signer or other financial backing, then the deceased borrower’s estate is responsible for paying back the loan. The following is an overview of other common types of loans and debt:
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- Auto loans: The estate usually pays off the auto loan but if the estate is insolvent and an heir doesn’t want to assume the auto loan debt payments, then the lender repossesses the car.
- Community property debt or joint debts: For any debt or property that was declared as joint ownership, regardless of whether the spouse’s name is on the loan, the spouse is responsible for the debt going forward. Some state laws may require a surviving spouse to pay the debts acquired by the deceased during their marriage.
- Credit cards: For joint credit card accounts, the spouse is required to continue paying off the debt. If there is no joint account, then the credit card company usually writes off the debt if your estate can’t cover the outstanding balance. Note: a joint account is not the same as having an authorized user on a credit card. An authorized user isn’t held liable in most states for the credit card debt. However, authorized users must not use the card after the person dies, as doing so is considered fraud.
- Home equity loans: If you borrowed against your home’s value through a home equity loan, the person inheriting your home would be required to pay it back.
- Medical bills: The rules regarding medical bills after someone dies vary state-by-state. A spouse may be responsible for these debts depending on the payment agreements signed at the time of a hospital admission. In other cases, health providers may write off the debt. Some states have laws making children liable for their deceased parents’ long-term care debt so check the rules in your state.
- Mortgages: If it is a joint mortgage, the mortgage transfers to the spouse when a husband or wife dies and becomes the spouse’s responsibility. If the deceased mortgage holder is the only one listed on the deed and there’s no will, the home becomes part of the estate.
- Student loans: Federal students loans are usually written off if the borrower dies, while private loans used for college will go through the probate process mentioned earlier. Unless there’s a co-signer, if there’s not enough money to cover the loan balance, it is usually written off when a person dies.
Protecting Loved Ones When Someone Dies
The best way to protect loved ones from a personal loan when someone dies is through a will that specifies how the assets will be distributed. Except in the cases of joint or co-signed accounts and loans, it is illegal for debt collectors to ask surviving family members to pay a deceased person’s loans—not that they won’t try—but you should know your rights in these situations. Creditors also can’t go after accounts with living beneficiaries (life insurance, retirement accounts, trusts, etc.). With education and careful planning, a family won’t be asking what happens to personal loans when a borrower dies.