A bank customer can secure his installment loan with residual debt insurance or residual credit insurance. In an emergency, the insurance company steps in and takes over the monthly installments in the event of unemployment or even the death of the borrower. In this way, the borrower protects himself and his surviving dependents against financial losses.
The residual debt insurance covers these risks
With residual debt insurance, a distinction is usually made between three types of insurance, which you can choose from:
- Protection in the event of death
- Protection in the event of death and incapacity to work
- Protection in the event of death, incapacity for work, unemployment through no fault of one’s own and in the event of a divorce
In the event of death, credit insurance relieves the relatives. This is particularly important for families with a main earner. In the case of incapacity for work, unemployment through no fault of one’s own, or in the event of a divorce, the borrower himself is protected against attachments and rising debts if he can no longer pay off his loan.
However, it is important to read and check the insurance contract carefully. Many risks are often excluded in the insurance terms of a residual debt insurance. This means that in an emergency you may not get the benefit for which you have actually taken out insurance.
Residual debt insurance in criticism
Knowing that you and your family are safe in an emergency is a good thing. However, residual debt insurance is not always the best and often not the cheapest way to do this. The residual debt insurance has been criticized and also targeted by consumer advocates for many years.
On the one hand, residual debt insurance is not a standardized insurance product. In contrast to, for example, home insurance, there are no exemplary conditions on which the providers of residual debt insurance can or should better orient themselves.
The lack of standards ensures that the benefits and the price of this insurance can vary widely from provider to provider. So if you have taken out residual debt insurance for your construction financing with insurer A, this does not mean that insurer B’s insurance for the car loan covers the same risks and pays in the same cases. Residual debt insurance is therefore a rather non-transparent insurance product.
Pressure when taking out a loan
Another criticism concerns the distribution channel of residual debt insurance – the way in which borrowers are sold residual debt insurance. It is often suggested to customers that they only get the loan if they take out residual debt insurance at the same time.
But this is not the case. In most cases, residual debt insurance is not mandatory, but voluntary. However, it can become mandatory if, for example, the borrower has a poor credit rating. If residual debt insurance becomes a prerequisite for a loan, it must be taken into account in the annual percentage rate. The increase in credit costs due to insurance must therefore be clearly recognizable in the interest rate shown. If the residual debt insurance is voluntary, it does not have to be shown. This in turn makes it difficult for the borrower to keep an eye on the exact costs – where we would be again at the first point of criticism “non-transparency”.
In addition, the sellers of residual debt insurance receive high commissions from the insurers – on average 50 percent of the insurance premium to be paid by the customer,. This makes residual debt insurance a fairly lucrative additional business for financial institutions.
Consumer protection strengthened
Since February 2018, providers of residual debt insurance have been obliged to send their customers a so-called product information sheet one week after taking out the insurance. In this letter, customers must be clearly informed that residual debt insurance is voluntary, there is a cancellation period and the existing credit contract is not endangered by termination of the insurance.
The cancellation period for the residual debt insurance only begins with the delivery of this information. It is then 14 days.
Alternatives to residual debt insurance
In order to have yourself and your family covered in an emergency, there are alternatives to residual debt insurance that also apply in the event of death or illness. All alternatives have a common advantage: They can be concluded independently of the loan, but still cover most of the risks that could jeopardize payment in installments. And they also make a lot of sense outside of credit protection.
When a residual debt insurance makes sense
Despite all the criticism of the residual debt insurance, it can still be used as credit protection for a certain target group. First of all, residual debt insurance makes sense, if at all, for very large loan amounts such as mortgage lending. These loans are often paid off over a long period of time. The longer an installment loan runs, the longer there is a risk that an insured event will occur. For smaller installment loans with short terms, you should refrain from residual debt insurance if possible. The costs are simply too high compared to the probability of an insured event occurring.