Paying your debts is honorable, and usually a legal requirement, but there exceptions when it can be erased, or it wasn’t really yours to start with
Law and ethics would say that if you have a debt, you must repay it. In most cases, that’s true. But there are certain situations where you’re off the hook.
Sometimes you may think you’re liable for a debt when, in fact, you’re not. Other times, you may be eligible to have your debt forgiven.
Following are seven debt situations where you may not be responsible for paying your debts, or the obligations of loved ones.
1. A spouse’s debt
In most states, spouses are not legally responsible for their partner’s debts.
“Individual debts are usually each spouse’s debts alone, unless the debt was for a family necessity such as food, housing [or] a kid’s tuition,” says Thomas Nitzsche, a spokesman for Atlanta-based ClearPoint Credit Counseling Solutions.
There are exceptions to this general rule, such as when you co-sign a loan. In addition, nine states — Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin — have mandatory community property rules. In those states, most debts incurred by one spouse are the obligation of both people in the marriage.
It is important to note that there is a lot of variation in rules from state to state, so it’s best to seek legal advice to find out which debt rules apply where you live.
2. Debt left behind by a deceased family member
Couples living in community property states will find that their spouse’s debts do not die with him or her, says Chelsea Barrish, a credit and housing counselor at Clarifi, a Philadelphia-based nonprofit financial literacy and debt counseling company. “If you live in a community property state, you may be responsible for most debts belonging to a deceased spouse if those debts were incurred during the marriage,” she says.
Outside of such states, you generally are not responsible for a deceased spouse’s debt unless you co-signed for a loan, Nitzsche says. Instead, the debt becomes the obligation of the deceased’s estate. The executor or administrator of the estate pays down the debt by tapping the assets left behind.
What happens if there is not enough cash in the estate to pay the bills? “The debt is simply written off,” Nitzsche says.
You also are not responsible for the debts your parents leave behind. Again, the debts are paid out of the estate. If the estate is too small to cover the obligation, the remaining debt typically is written off. So do not let creditors hassle you for these debts. “Survivors can provide a copy of the death certificate to the creditors if they wish to stop collection activity or provide closure,” Nitzsche says.
Student loan debts have their own rules. If the borrower dies, federal student loans will be discharged. Same goes for if you are a parent PLUS loan borrower and you die or the student dies. Private student loans, however, don’t necessarily follow the same policies. Check with your lender to find out specifics.
3. Debt incurred as a minor
Debtors younger than age 18 generally get a free pass on their debt. That makes sense, because legally they are not allowed to go into the red in the first place. “Minors should not be allowed to incur debt, since they cannot enter into contracts,” Barrish says.
The situation changes if the minor has incurred debt with an adult co-signer. “The co-signer would be responsible for it,” Barrish says.
That’s one reason credit counselors caution against co-signing loans. If the borrower for whom you co-signed does not pay up, it becomes your obligation.
4. Very old debt
Each state places a limit on the amount of time a creditor may pursue debt repayment. This protects you from creditors who otherwise might hound you long after most evidence of your debts has disappeared.
Individual debts are usually each spouse’s debts alone, unless the debt was for a family necessity such as food, housing [or] a kid’s tuition.
|— Thomas Nitzsche|
ClearPoint Credit Counseling Solutions
The statute of limitations on debt varies by state. Also, the time limit may differ for various types of debt. In general, the statute of limitations for credit card debt ranges from three years to six, but a few states may stretch that time period to 10 years.
Once the statute of limitations on a debt expires, the obligation becomes time-barred. That means if you get sued by a creditor, you can get the case dismissed. However, collectors can continue to try to pursue the debt even though you do not legally have to pay it.
If you decide to pay the debt, know that in some states, partial payment or even the promise of payment of a time-barred debt restarts the clock on the statute of limitations. “A partial payment on an old account might restart the period of time that you can be sued,” says Joanne Kerstetter, vice president of education for Money Management International in Sugar Land, Texas. “So be very careful when deciding what to do with these debts.”
Also, old, unpaid debt may still hurt your credit score, Nitzsche says. “It will show on your credit report for seven years from the time it went into collections, regardless of the statute of limitations,” he says.
5. Student loan debt, contingent on hardship or some kinds of public employment
Federal student loan debt may be discharged if you become permanently or totally disabled and, in some cases, if you file for bankruptcy.
In the case of bankruptcy you must meet three criteria:
- Repaying the loan would mean you cannot maintain a minimal standard of living;
- There is evidence that hardship will continue for a significant portion of the loan repayment period; and
- You tried to repay the loan before filing for bankruptcy (usually for a minimum of five years).
Although the federal government calls these cases rare, a 2011 Harvard Law School study found that judges grant hardship discharges to nearly 40 percent of debtors that seek one. Those that were successful in receiving the discharge were less likely to be employed, more likely to have a medical hardship and more likely to have lower annual incomes the year before they filed for bankruptcy.
“There can also be public service loan forgiveness, which is offered for student loans,” Kerstetter says. In such situations, student loan debt is canceled for people who work for certain government agencies or nonprofit organizations.
6. Unauthorized debt on a credit or debit card
If someone steals your credit card and uses it, according to the federal Fair Credit Billing Act you are legally protected from having to pay most of the charges. The same protection applies when people simply use the card without your permission.
“Typically, if there are unauthorized transactions on your credit card, the most you could be liable for is $50,” Barrish says. Most credit and debit card issuers have zero-liability policies that protect you from losing any money in cases of fraud or theft, but they’re not all the same.
Typically, if there are unauthorized transactions on your credit card, the most you could be liable for is $50.
|— Chelsea Barrish|
Credit and housing counselor, Clarifi
Barrish urges cardholders to promptly report a lost or stolen card, or any unauthorized charges on a card. If you report the loss of a credit card before any charges are made, you are not liable for a single penny of the fraudulent charges.
Promptly reporting the loss of a card is especially important for debit cards, which don’t enjoy the same protections under the federal law. “Your liability can be considerably higher, depending on how quickly you notify your bank,” Barrish says.
If you report the loss of a debit card within two business days, your liability is limited to $50 in fraudulent transactions. Report the loss more than two business days after the theft — but less than 60 days after your statement is sent to you — and your obligation can be as much as $500. After 60 days, you may be held liable for all losses, including those that occur to accounts linked to the debit account.
Once you report the card’s loss, you cannot be held liable for any transactions that occur after that point. Also, you are not liable for transactions that occur if someone steals your account number — but not the debit card — if you report them within 60 days of your statement being sent.
7. Forgiven debt
Creditors sometime cancel part of a debtor’s financial obligation, often as part of a debt settlement. This is known as debt forgiveness.
Forgiveness is different from a write-off, which simply means the creditor has registered the debt as a loss on their books. With a write-off, you’re still obliged to pay the debt.
If a creditor truly forgives part of your debt, keep proper documentation of the event for future reference. “Make sure that you have the statement for paid in full from the creditor,” Kerstetter says.
Also, ask how the forgiven debt will be reported to the credit bureaus. “Some creditors will report paid in full without any derogatory information submitted to the credit bureaus,” Kerstetter says.
While forgiven debt can offer relief, it sometimes leaves behind a nasty shock for the debtor. Come tax time, you may receive a 1099-C form indicating that you owe taxes on the forgiven amount. That is because the Internal Revenue Service considers forgiven debt to be income. The IRS requires creditors to file a 1099-C form when they forgive at least $600 of debt.
There are, however, exemptions to canceled debt obligations, and it’s worth checking to see if you qualify for one of them.