If a relative or loved one dies owing money, does it fall on their next of kin to cover any unpaid debts? Generally speaking, you won’t be called on to foot the bill for any money owed by a relative or loved one, but there are a few exceptions. We explore the main ones below.

First of all, how are debts paid when someone passes away?

A deceased person’s debts will typically be repaid through their estate before anything can be distributed to their nominated beneficiaries.

This process is handled by either an executor appointed by the deceased or (if there is no valid Will) an administrator appointed by the courts.

Debts are usually paid off in order of priority, with tax debt usually at the top of the list. Unsecured debts are considered less important and are generally handled last.

If there is enough cash in the estate, the executor or administrator should be able to settle all debts using the money available. But if the funds fall short, they might resort to selling assets left behind by the deceased, such as property and shares. If all available assets have been exhausted and there is still money owing, then insolvency rules might kick in and these debts will be written off.

Which debts can be ‘inherited’?

While a deceased person’s relatives and loved ones typically cannot directly inherit their debts, there are a few circumstances where creditors can seek payment from them. The three main examples are:

• Guaranteed debts
• Debts that were taken out jointly
• Debts that were secured against assets you own

Example #1: You have guaranteed someone else’s loan

If you go guarantor on someone else’s loan, you agree to repay the amount they borrowed (or part of it) in the event they become unable to do so themselves. This arrangement is common between property-owning parents and children who would otherwise struggle to get their home loan application over the line.

Often, guarantors will be required to put up the equity they have in their own home as security. If the borrower passes away and neither the guarantor nor the money or assets from the deceased’s estate can cover the mortgage repayments, the lender might take possession of the guarantor’s home.

Example #2: You have debt that was taken out jointly

If you were a co-signatory on a loan with someone who subsequently passes away, you may be liable to repay the remaining balance yourself (that is, unless the estate is able to pay the full amount).

For example, if a married couple takes out a mortgage together and one partner dies, the surviving partner will still be on the hook for the remaining debt. Some people might have no issue assuming full responsibility for the loan, but others might struggle, especially if they weren’t the primary income earner.

If the deceased had a life insurance policy, any payout received might be able to cover the ongoing repayments or even pay off the mortgage in full. But if there was no life insurance policy in place and there’s no way for the surviving spouse to afford the repayments, they might be forced to sell the property.

Example #3: You secured someone else’s loan against an asset you own

Another scenario where you might be obliged to cover part of a deceased person’s debt is if you agreed to secure their loan against one of your assets. If the estate doesn’t have enough funds to pay the amount owed, the asset you offered up as collateral might have to be sold.

If the above three circumstances don’t apply to you, it’s unlikely that a lender will chase you up for payment following a family member’s death. But if you’ve entered into one of these arrangements, or you’re thinking about doing so, it’s important to be clear on what your obligations are.

Consider speaking to a financial adviser or lawyer. An adviser can help you determine whether you’re in a position to attach your name or assets to someone else’s loan, while a lawyer can help you draft up an appropriate agreement that ensures your interests are considered.