Insurance Caution: Experts Advise Against It - Unrecommended Choice
Residual debt insurance, also known as residual loan insurance or installment protection insurance, is a type of risk insurance designed to ensure that a loan is repaid in the event of the borrower's death or disability. While it aims to protect both lenders and borrowers, it has faced criticism due to several concerns.
One of the primary issues is the cost and value of residual debt insurance. Experts have labelled it expensive, often because it only covers specific events such as death or disability and may have strict exclusions or conditions. The consumer center states that it provides little coverage, and many intermediaries are not experts in the field.
Another concern is the limited scope of coverage. Residual debt insurance typically does not cover other risks like unemployment or income loss, which can also affect a borrower's ability to repay a loan. This lack of comprehensive coverage has led to questions about its effectiveness.
Furthermore, there are transparency and consumer protection issues. Borrowers may not fully understand the terms, costs, and limitations of residual debt insurance, leading to potential dissatisfaction or misaligned expectations. The additional costs of this insurance do not always have to be shown in the effective annual interest rate, according to a report.
Despite these criticisms, 29 percent of consumers surveyed by BaFin in 2019 had taken out residual debt insurance to secure their loan. However, it is not clear whether this insurance is mandatory when taking out a loan.
Given these concerns, better alternatives for loan protection are being explored. Income-contingent repayment plans, which adjust repayment amounts based on the borrower's income, are seen as a more effective solution. They provide a form of insurance against income shocks without overly discouraging work effort.
Broader loan protection insurance products that cover unemployment, critical illness, or temporary disability are also being offered by some insurers. These policies provide better protection aligned with common risks affecting borrowers.
Flexible government or lender assistance programs that allow temporary payment pauses, restructuring, or forgiveness under hardship conditions can act as alternatives or supplements to insurance.
In summary, while residual debt insurance has been a popular loan protection option, its narrow coverage, cost, and potential economic distortions have led to criticism. Alternatives like income-contingent repayment and comprehensive protection plans offer more effective support for borrowers facing repayment difficulties.
Personal-finance experts often find residual debt insurance to be overly expensive due to its limited coverage and specific event-based protection, often with strict exclusions or conditions. Improved alternatives for loan protection, such as income-contingent repayment plans and comprehensive insurance policies that cover unemployment, critical illness, or temporary disability, are considered more effective in personal-finance management.
