According to a new Insuredcircle study, 35% of Americans who purchase life insurance do so to cover significant debts for which others would be liable. Learn more about how debt is passed down through families and what types of debt you may want to cover.

What happens to your debts after you die?

When you die, the assets in your estate are generally used to pay off your debts. If there is insufficient money in the estate to settle the debt, it is not paid. However, in some cases, other people may be held liable for the remaining balance.

• Cosigners and joint owners: If someone cosigns your debt, they are usually liable for it after you pass away. A joint owner of a debt is also equally liable for it. So, if you or a joint owner die, the surviving member is responsible for paying off the balance.
• Spouses: In states where community property exists, surviving spouses are liable for debts left by deceased partners. Community property states include Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. Community property rules are optional in Alaska, South Dakota, and Tennessee. Spouses may be held liable for certain debts, such as health care, in some states.

Even if no one is legally obligated to pay your debts after your death, you may still want coverage. A life insurance payout can assist your beneficiaries in repaying debts so that the money in your estate can be distributed to your heirs. You can also use life insurance to leave your estate with a separate inheritance.

Covering debt: Term or permanent life insurance?

Term life insurance is usually sufficient for most families and is a popular way to cover debt. These policies are intended to last for a set period of time, such as 10 or 20 years. You can select a term length that corresponds to the length of the loan. If you have a 20-year mortgage, for example, you can purchase a 20-year term life policy.

Permanent life insurance is the other type of life insurance. These policies, unlike term life insurance, are permanent and can last your entire life. A permanent policy, such as whole life insurance, may be a good fit if you want your beneficiaries to receive the death benefit regardless of when you die. Permanent policies, on the other hand, are more expensive than term life policies, and you may not require lifelong coverage.

What type of debt does life insurance cover?

Beneficiaries can spend a life insurance death benefit however they see fit, including paying off debt. Mortgages, credit card bills, and personal loans are just a few examples of debts that an insurance policy can help settle after you die.

Using life insurance to pay off a mortgage

If you cosigned your mortgage or were a co-borrower on the loan, they would be liable for the debt if you died. Making them the beneficiary of a life insurance policy allows them to pay off the debt and keep the house.

If no one is liable for the debt and your estate lacks sufficient funds to cover the mortgage, the lender may foreclose on the property. However, if a person inherits a home and wishes to keep it, they are usually permitted to continue making mortgage payments. If this occurs, a life insurance payout can assist them in covering the costs. Even if your heirs are not legally obligated to pay the mortgage after your death, they may benefit from a life insurance payout.

Mortgage protection insurance vs. term life insurance

Mortgage protection insurance is an optional coverage offered by lenders when you buy a home. If you die with a mortgage balance, these policies pay it off. The money is paid to the lender, not to your family.

Term life insurance is frequently less expensive than mortgage protection insurance and offers the same coverage with more flexibility. A term life insurance payout is made to your life insurance beneficiary and can be used for any purpose.

Using life insurance to pay off student loans

Because student debt is frequently forgiven after death, life insurance may not be required.

For example, if you take out a federal PLUS loan for your child's college expenses and die, the debt is discharged.

Even if you cosign a private student loan, you may not be liable if your child (the borrower) dies. This is due to the Economic Growth, Regulatory Relief, and Consumer Protection Act, which requires lenders to release cosigners from any obligation to pay off the debt if the borrower dies after 2018.

If your child relies on your income to pay off their student loan and you die, a life insurance payout can assist them in covering the debt in your absence. If you take out a private parent loan for your child, you should also consider purchasing life insurance. These loans are typically not discharged if you (the borrower) die, which means the debt will be included in your estate. The proceeds from a life insurance policy can be used to pay off debt rather than your assets.

Using life insurance to pay off credit card debt

A cosigner or joint owner of your account may be responsible for the remaining balance on your credit cards. Purchasing a policy to cover the amount you owe can assist your beneficiaries in repaying it if you die. Authorized users, such as partners or children, who have access to the account's credit cards, are not liable for the debt.

Credit life insurance vs. term life insurance

Lenders may offer credit life insurance, but it is not always the best or cheapest option. In these policies, the death benefit decreases as the loan is paid down, but your insurance premiums remain constant. Furthermore, the death benefit is paid to the lender to settle the debt rather than to your beneficiaries.

In comparison, term life insurance pays out to your beneficiaries rather than the lender. Furthermore, the death benefit is typically not reduced as the loan is paid down, so your beneficiaries receive the full amount if you die during the policy's term.

Using life insurance to pay off business loans

Following your death, the payout from a life insurance policy can assist your business partners in repaying any loans for which they are now solely responsible. Even if your partners are not required to repay the loan, a life insurance payout can assist in covering expenses during a difficult time. A buy-sell agreement, which allows partners to buy out the deceased partner's stake in the company, can also be funded by life insurance.