Unfortunately, our debts don’t disappear if we die. In fact, they are handed over to the people who are closest to us to deal with. This is a huge responsibility to leave someone. There are 3 main factors that determine what will happen if you have a mortgage when you die: your will, your mortgage agreement and your insurance policies.
Who inherits your home loan debt?
The person who inherits your house will also inherit your mortgage repayments. While you may not get a say in whether the house is kept or sold, you can ease the burden of that decision by entering into any mortgage agreement with your eyes wide open.
Most commonly, a home loan is co-signed with a spouse or partner. If this is the case, the co-borrower automatically assumes the mortgage and is responsible for the debt remaining.
If you are the sole borrower on your property and you pass away, the responsibility for your debt goes to the person you name as the beneficiary in your will. In the event of your death, the bank has the right to request the payment of the loan in full from this beneficiary. Ideally, you will have enough assets to pay off the home so they can inherit it in full. Alternatively, there could be enough equity in the property that it can be sold to pay off the loan with extra left over for the beneficiary.
This means there might be some hassle and paperwork, but the beneficiary should end up with some money at the end. The problem comes if the property and your other assets can't cover the whole debt.
When your mortgage debt outweighs your wealth
If there isn't enough equity or assets, it can become a big problem for the beneficiary. According to solicitor Rod Cunich of Slater Gordon, mortgages have an all money clause. "You can sell the house to try and pay it off but if there is a short fall, your bank has the right to sue you and take your other assets to make up the difference," he explains.
In some situations, borrowers will have a guarantor loan. This type of loan enables people to enter the property market, purchase a property they could otherwise not afford or put down a bigger deposit and avoid paying lenders mortgage insurance (LMI). The guarantor offers up their own property as security for your loan. In the event of your death, the bank will expect the guarantor to cover the debt or difference between what the house sells for and what is owed.
Tips for being prepared with your home loan
- Enter into your mortgage with your eyes wide open. Make sure you fully understand the lender's policy for what happens in the event of your death and have a signed agreement with any co-borrowers or guarantors that outlines where the money will come from and who is responsible for executing it in the event of your death.
- Encourage guarantors and co-signers to address your mortgage in their own will and insurance options.
- If you are considering being a guarantor, put some boundaries in place such as the amount you are willing to guarantee (limited guarantor loan options are available), take out adequate insurance for yourself and insist that the borrowers you are guaranteeing have insurance as well.
Wills and mortgages
A will is the key to ensuring your wishes are carried out in the unfortunate event of your death. A will clearly distributes your assets and gives instructions about your funeral and any legal outcomes.
You can specify who inherits your property when you die in your will. If you have outstanding debt on your property, then whoever inherits the property (your children, for example) now own the property. They have 2 options:
- Continue to own the property and repay the mortgage.
- Sell the property to pay off the mortgage and pocket the leftover money.
Here's what the experts have to say about your will and how it affects your mortgage debt.
If you don’t have a will
If a person dies without a valid will, they are said to die "intestate". In this case, the government employs a default will, appoints an executor of their choice and divides your assets, including your house, according to a particular formula. Each state in Australia has a different process and formula, and it may not be the formula you would choose yourself.
According to Cunich, the national practice group leader for succession and wealth management at Slater Gordon, intestate can get very complicated, especially in the event of divorce and blended families, and the variation in how each state approaches it is huge.
"In NSW, for example, if a person is married but separated and has a new de facto spouse, both are considered spouses with an equal claim to the assets. In another state, the former spouse might get the first $50,000 and then the rest would be divided with the new de facto spouse. It can get messy very quickly."
If you have a will
A will is considered legal if it’s written by someone over the age of 18 who has mental clarity and is signed by 2 objective witnesses. It needs to completely dispose of all of your assets and be up-to-date with your current circumstances. New assets like a business, or a change to your family situation like children or divorce, must be updated as soon as possible.
While will kits can be purchased through Australia Post and can even be completed online, you should ideally prepare your will with the assistance of a solicitor who specialises in the area of wills and estates. They will be able to advise you for your particular situation and ensure you have thought through everything completely.
Tips for preparing your will
- Keep a copy of your will with your important paperwork and include a note on the front stating where the original is and who to contact if you should die.
- Ensure your will is valid by updating it annually or as soon as your financial or family situation changes.
- Keep in mind that any beneficiary you name for your property will also be responsible for the debt you have remaining on it.
How insurance can help cover your debts if you die
While your death might mean you are passing on a significant amount of debt and responsibility, you can take steps to minimise or even eliminate that stress right now.
Life insurance
A life insurance policy will pay out a lump sum to the designated beneficiary in the event of your death – usually to your spouse or remaining family members. "Something that many people don’t realise is that life insurance is a protected asset," Cunich explains. "This means it isn’t automatically applied to debt but given to the assigned beneficiary as a lump sum. A good life insurance policy is usually enough to pay off the house and replace the income you were bringing in to cover bills, education costs and the costs of raising a family."
"Keep in mind that the assigned beneficiary is not forced to pay debts with the life insurance amount. If the beneficiary gets bad advice or chooses to spend the money elsewhere, they could still end up losing the house," Cunich warns.
Mortgage protection insurance
There are 2 types of mortgage insurance, but only 1 that works in your favour if you should happen to die. Lenders mortgage insurance (LMI) is compulsory if you borrow more than 80% of the house value but it doesn’t protect you at all. This insurance protects the lender if your house is repossessed.
Mortgage Protection Insurance, on the other hand, protects you and covers your mortgage repayments in the event of death, sickness, unemployment or disability. This form of insurance is generally more expensive than life insurance and it is not necessary to double up specifically for death cover. It can be very beneficial if you are planning on leaving your house to a different beneficiary than who will be getting your life insurance, or if you don’t have income protection or trauma insurance.
Other insurance policies
Other forms of insurance can provide payments if you are injured and unable to work. These can help cover your mortgage repayments. You may want to look at income protection insurance or TPD insurance.
