Can life insurance be used to pay off debts?
Life insurance policies are often taken out in order to provide a pay-out to the policyholders loved ones should they die, leaving them in a financially stable position. But can they be used to pay off debts?
Yes, a life insurance pay-out can be used to pay off debts. In fact, that’s one of the main reasons people take out a life insurance policy: to ensure they won’t leave behind debts for their loved ones to deal with should they die unexpectedly.
When you die, your estate - which includes everything you own, including money, property, and possessions - will be used to pay off any outstanding debts you have. But many of these debts, such as debt on credit cards or loans taken out solely in your name, can’t be inherited.
Additionally, if your life insurance policy is written in a certain way, “in trust” with a named beneficiary, it won’t be counted as part of your estate. That means creditors won’t be able pursue your survivors for the life insurance pay-out to settle your debts.
But there is a major exception to this for most people: mortgages. Most mortgages are taken out by two people and will therefore survive the first person's death.
They’re also a form of secured debt, a loan taken out against the house. That means your surviving partner and your family will have to settle the debt in order to keep the house.
People often take out life insurance policies alongside mortgages (some lenders will even require this) so their family can pay off the balance and own the home outright and their partner doesn’t have the shoulder the mortgage bills on their own.
Decreasing term life insurance policies are ideal for this, with the pay-out aligned with the remaining balance on your mortgage and the policy lapsing when you've paid off the mortgage.