What is residual debt insurance?

Residual debt insurance is used as part of loan protection. It is therefore also known as a loan life insurance or residual loan insurance. The insurance is intended to provide for the event of payment incapacity or the death of the borrower. If a payout occurs, for example in the case of illness or unemployment, the capital sum is assigned to the lender. This type of loan security is regularly used for mortgages.

Terms and benefits of residual debt insurance

What does residual debt insurance do?

Residual debt insurance is a financial support for emergencies. An unplanned financial setback can affect anyone. If you find yourself unable to pay the ongoing costs for a loan, residual debt insurance can be a lifesaver. Residual debt insurance steps in, for example, when the borrower is unemployed for an extended period or in the event of a serious illness.

In addition, the insurance functions like a classic life insurance policy — but in this case the bank is listed as the beneficiary. The loan debts therefore do not fall onto the surviving family members. This type of protection is especially important when there is only one main earner in the household. If the regular income disappears, the remaining family members are often unable to maintain their accustomed standard of living without insurance.

What does residual debt insurance cover?

The basic form of residual debt insurance has been offered since the 1950s. The idea originated in the USA. The first form for the German market was approved in 1957 by the Federal Supervisory Office for Insurance (Bundesaufsichtsamt für das Versicherungswesen).

Today, insurances are available in many different forms. The differences concern both the payment method and the costs and payout modalities. Among others, the following models are available:

• Classic life insurance - pays out in the event of death
• Disability insurance - pays out in the event of occupational disability for the insured profession
• Unemployment insurance - pays out in the event of involuntary unemployment
• Dread-disease insurance - pays out in the event of serious illnesses (cancer, heart attack, stroke and up to 20 other illnesses)

In addition, insurers also offer benefits aimed at re-integrating the insured into working life. For example, they can provide financial support for therapy or retraining measures.

Note: The conditions should always be checked and compared carefully before taking out an insurance policy.

Due to the wide range of available insurances, it is important to carry out a comprehensive comparison before signing. For example, a dread-disease insurance may exclude conditions for which there is already a known family history. Disability insurances can be defined very narrowly and may only come into effect from a very high degree of incapacity. There are also special conditions that, for example, determine whether the insured must show general incapacity to work or only incapacity for a specific occupational field.

A direct comparison quickly shows the advantages and disadvantages of the individual policies. In an emergency, it is always advisable to seek advice from a specialist.

When does residual debt insurance pay out?

Depending on the chosen policy, each insurance works with different terms. As a result, there are different waiting periods, elimination periods and benefits. This point is important when choosing the right policy. The following are some examples of possible waiting periods and benefit limitations.

What exactly is meant by waiting period and elimination period in residual debt insurance?

Definition: Waiting period

The waiting period describes the period after the insurance is taken out in which no claims can be made.

Definition: Elimination period

The elimination period begins immediately after a claim is submitted. Payments are only released after the elimination period has elapsed.

Insured event: Death

If the insured person dies, the agreed insurance sum is paid out or the remaining debt is assumed by the bank. For this type of insurance there are neither waiting periods nor elimination periods.

Insured event: Disability to work

In the case of disability to work, the insurance often takes effect after six weeks. It is not common to work with a waiting period. Classic policies cover the remaining installments in full.

Insured event: Unemployment

Unemployment insurances have a waiting period of 1 - 6 months. The elimination period is usually set at three months. The insurance covers the installments for a period of up to 18 months.

There are a number of exclusions. If unemployment, for example, is the result of a voluntary resignation, the insured person has no entitlement to benefits.

Insured event: Divorce

Divorces can also be insured. Proof of a legally binding divorce is required for the payout of a contractually agreed capital sum. The waiting period is up to three months. If the divorce is filed within the year of the insurance conclusion, all insurance claims expire.

Exclusion clauses for residual debt insurance

The exclusion clause in insurance policies lists a number of special cases that relieve the insurer of the obligation to perform. The clause is valid for two years after the insurance contract is concluded. If, for example, a condition occurs during this time that is caused by a pre-existing illness, the insurer may refuse payment. Many insurers also only pay benefits up to a specified age.

Advantages and disadvantages of residual debt insurance

What are the advantages of residual debt insurance?

For taking out a residual debt insurance, there is generally no elaborate acceptance and health examination. This means a quick contract conclusion is possible. A private law protection for the case of involuntary unemployment is offered exclusively by residual debt insurance.

• Quick contract conclusion possible
• Uncomplicated acceptance
• Protection in the event of involuntary unemployment possible

What are the disadvantages of residual debt insurance?

Taking out a policy rarely leads to an improved credit scoring and therefore does not necessarily provide a real advantage for loan approval. If the bank requires the insurance, the costs are included in the loan as an effective interest rate. The policies are usually subject to very specific waiting periods that can prevent a payout. The elimination periods are also not always beneficial for the insured if the emergency occurs and the payout of the insurance premium is urgently needed.

• No improved credit scoring
• Additional costs for the loan
• Long waiting and elimination periods

Terminating a residual debt insurance

Can residual debt insurance be terminated?

It is possible to terminate residual debt insurance. This is interesting for a refinancing or the early repayment of the loan. It is also possible to terminate the insurance extraordinarily.

Use the special right of termination for residual debt insurance

If a loan is refinanced, it is not automatically the case that the residual debt insurance expires. It usually needs to be terminated separately. If the insurance was paid with a lump-sum at the time of signing the contract, the termination should state that the insured person wishes to receive the proportional premiums back. If a loan has been repaid, the purpose of the insurance ceases and the premiums already paid are no longer valid. Thus, the insured person has a special right of termination.

Ordinary termination for residual debt insurance

If the contract provides for an ordinary right of termination, the policy can also be terminated during the loan term. In this case, the contractually agreed notice period must be observed. This is often two weeks to the end of the month. In this case as well, insured persons are entitled to the payout of unused premium portions. It may happen that a cost share for the initial commission and for cancellation deductions is deducted from the refund. There is no uniform regulation for this.

Attention! Insured person or policyholder
Depending on the contract, it is possible that the contracting party is not registered as the policyholder but is only recognized as the insured person. The policyholder would be the bank in this case. This arrangement would make it impossible for the borrower to terminate the contract ordinarily.

Does the residual debt insurance end automatically when the loan is repaid?

Since the insurance is directly linked to the loan, it automatically loses its validity after the loan is repaid. This is because a payout benefits the bank. If there are no outstanding amounts with the bank, it has no entitlement to payments.

It does not matter which type of premium payment was chosen for the insurance. A one-time capital payment covers the loan period just as monthly premiums do.

Costs of residual debt insurance

The actual costs for the insurance are determined by a number of factors. Basically, the premium contribution depends on the sum to be insured and on the type of insurance. Policyholders can choose between two basic models:

Residual debt insurance with a lump-sum payment: A commonly used model covers the entire premiums at the start of the insurance with a one-time payment. The capital for the insurance is co-financed through the loan - this causes higher total costs for the loan. The extra costs are repaid together with the loan over the repayment period.

Residual debt insurance with monthly installments: Monthly installments are always adjusted to the current outstanding balance. This means the payments decrease over time. In both cases, additional costs can arise. These can be commission costs for the bank or processing fees.

How is residual debt insurance calculated?

The premiums are based on the amount of the outstanding debt and the specific contractual conditions of the loan. Among other factors, the following play a role:

• Classic installment loan or mortgage financing?
• Duration of the loan
• Amount of the loan
• Age of the insured
• Type of insurance

What to consider with residual debt insurance?

When is residual debt insurance sensible?

Banks offer residual debt insurances for a variety of loans. Whether the policy is necessary in an individual case must be decided individually. It is not generally advisable to take out the insurance. A good bank advisor will show all options in detail and determine the individual need.

A few questions should be clarified before signing:

• Are there already other insurances?
• What sum needs to be insured?
• Which type of residual debt insurance is best suited?
• How high can the costs for the insurance be?

Residual debt insurance for installment loans

Since there are no fixed rules regarding the contractual design of a residual debt insurance, it is difficult to make a general statement about the financial products. Depending on the provider, they offer a good price-performance ratio — or not. Generally, however, they are offered for installment loans by more and more banks. They can be used, for example, for an installment loan to finance a car or for renovations.

Residual debt insurance for mortgage financing

Residual debt insurance is often a sensible option when taking out a mortgage. It serves to secure the loan amount. If the borrower dies before the end of the mortgage repayment, the surviving family members are secured in this way.

If the insurance is taken out in the form of a term life insurance, it is available in two models. On the one hand, a one-time capital payment is insured, which does not change over the entire term. On the other hand, the actual value of the outstanding debt can also be insured.

Tip: Regardless of the financing amount for the mortgage, it is advisable to have comprehensive insurance coverage. Insurance gaps, for example in the area of occupational disability, can in the worst case even lead to financial ruin. The consequences are usually far-reaching. In addition to the loss of the property, all other areas of life are affected.

Risk of double insurance

The basic idea of residual debt insurance is similar to that of a term life insurance. If occupational disability, accident or death are already covered by existing policies, it is not necessary to take out additional protection. Only the area of involuntary unemployment can be covered exclusively by residual debt insurance.

Therefore, it is important to scrutinize existing policies before concluding a new one. Compared to a classic term life insurance, the costs for this special type of insurance are relatively high. A potential double insurance is unnecessary and, moreover, very costly.

Right of revocation for installment loans with residual debt insurance

If the loan agreement has already been concluded, the contract is no longer terminable. In special cases, however, it is possible to file a revocation, because this financial product has no statute of limitations. If the revocation is accepted, the interest rate can be adjusted. This is particularly worthwhile if the current rate is far above the market rate. After such an adjustment, the premiums can be adjusted to the new amount, which can lead to a partial refund.

Market interest rates and unwindment

If a revocation is filed, the loan agreement enters a unwindment relationship. This case is governed by the German Civil Code (BGB) (§§ 357 para. 1 sentence 1, 346, 348 BGB). If the revocation is filed during the loan term, the borrower has 30 days to repay the outstanding amount to the bank. This means the required capital should be available at the time the revocation is submitted. If the revocation is asserted due to an incorrect revocation instruction, only the net loan amount must be refunded at market interest rates.

In the context of a legal revocation, the financial institution is obliged to refund the financial services already provided (interest and repayments) in full. The contractually agreed interest for the provision of capital may be retained by the financial institution. If the borrower can prove that these interest rates were above the market rate at the time of contract conclusion, the interest rate can be corrected.

Residual debt insurance and other insurances

Residual debt insurance or term life insurance?

Consumer protection organizations often warn about the risks and disadvantages of residual debt insurance. This is because there are a variety of financial products that offer a better price-performance ratio than residual debt insurance. Classic term life insurance is one such alternative.

Framework conditions of term life insurance

A life insurance is available in two options. Consumers can choose between a capital-form life insurance and term life insurance. The costs for a capital-form life insurance are higher than for term life insurance. If the capital-form life insurance is not needed within the contract framework, the insured receives a capital payment after the contract expires. Term life insurance only pays out in the event of death.

Term life insurance offers high coverage amounts for comparatively low premiums. It is very suitable for securing real estate and land. The advantages of this insurance are clear:

• High coverage amounts possible
• Low premiums
• Valid even after the loan expires

Do banks recognize existing term life insurances?

Liberal financial institutions consider a term life insurance sufficient security without being listed as the beneficiary on the policy. However, the sum insured is relevant. If the total value of the mortgage loan is far above the term life insurance amount, it is very likely that additional security will be requested. For mortgage financing, this is usually the mortgage deed (Hypothekenbrief). This registers the land charge for the property in the land register. If the mortgagor becomes insolvent, the property is sold to settle the outstanding debt with the bank.

Complementary insurances to residual debt insurance?

Comprehensive insurance coverage is prepared for all risk areas. Consumers are often unaware of the possible circumstances that can lead to payment incapacity. A life insurance is considered sufficient by a large proportion of borrowers.

There are many factors to consider. What if an accident causes a longer period of work incapacity? High additional costs for rehabilitation must also be taken into account. In the worst case, an accident can result in occupational disability. Regular income is then no longer available. A serious illness always comes unexpectedly. Cancer, a heart attack or a stroke bring life to a standstill. With suitable insurance, the financial aspects are secured and one can fully concentrate on recovery.

In the event of a divorce, the finances of both parties are directly affected. A jointly taken mortgage causes many problems. If the loan is insured separately, this is a reason to worry less.

Involuntary unemployment can affect anyone at any time. Even people who have been in a stable employment relationship for decades can find themselves in this situation. Appropriate protection can be very valuable.

Possible additional insurances alongside residual debt insurance include:

• Accident insurance
• Occupational disability insurance
• Dread-disease insurance

Residual debt insurance - concluding the contract

Why do banks often offer residual debt insurances?

For the financial institution, any form of insurance is a welcome protection. The more securities available, the lower the risk for the bank of being left with the costs. Therefore, it is not surprising that bank advisors try to create as comprehensive a safety net as possible.

Unfortunately, advisors do not always act in the best interests of their clients. Insurers pay high commissions to banks for the conclusion of policies. The insurers then pass the commission costs on to the premiums — which increases the total costs for the residual debt insurance.

Tip: Independent advice is offered by a fee-based advisor. These financial advisors work independently and receive no commissions from insurers. The costs for a fee-based consultation usually amount to a few thousand euros. In return, a good financial advisor can significantly optimize the total costs for insurances, mortgage financing and other financial products.

When is the residual debt insurance concluded?

The insurance is always taken out together with the loan agreement. If the one-time premium payment is co-financed through the loan, the insurance is valid as soon as the payment has been made. Monthly premium payments are included in the loan installments. The bank forwards the payments to the insurer.

Is the obligation to take out residual debt insurance lawful when concluding a loan?

Banks like to present residual debt insurances as an advantageous financial product. It is often portrayed as if taking out the insurance affects loan approval. Consumers thus quickly feel obliged to take out an insurance to secure the loan. However, this is only actually the case in very rare instances. The insurance has little influence on credit scoring and thus on the granting of the loan. In special exceptional cases the insurance may be mandatory — for example to enable loan approval for a high-risk customer. It should be considered that banks receive commissions from insurers for successful completions. If the contract is concluded thoughtlessly, every consumer has a right to cancel within 30 days of the contract conclusion.

Are loan and residual debt insurance connected transactions?

If residual debt insurance is taken out together with a loan product, this is legally referred to as a connected transaction. The special circumstances of the connected transaction are therefore pointed out in the revocation instructions.

If the revocation instructions do not point this out, they are legally considered insufficient. Due to this error, the insurance contract and the loan contract are contestable. Even after both financial products have expired, it is thus possible to secure a refund of costs, as already described.

Tip: Anyone involved in a legal dispute concerning a loan agreement with residual debt insurance should contact a consumer advice center. For a fixed fee, the center checks the revocation instruction for correct content. If an error is found, the center provides a template letter. With this, an official revocation can be initiated. Once this is submitted, consumers have the opportunity to demand a refund.

Residual debt insurances - Key points at a glance

• Residual debt insurance is taken out in combination with a loan. This can be an installment loan or a mortgage.
• The costs for the insurance are calculated according to the payment method and the loan amount.
• There are a number of insurance options for residual debt insurance. In addition to coverage as life insurance, consumers can also insure occupational disability, serious illnesses, involuntary unemployment and divorce.

How sensible is residual debt insurance for borrowers in reality?

Residual debt insurance is not a good choice for every consumer. If there is already sufficient insurance coverage through other policies, the insurance only causes unnecessary extra costs. Since the base loan finances the costs, it automatically increases. This raises the total costs for the loan — the costs for the residual debt insurance are additional to the premiums.

Exception: Loan approval can in special cases be tied to the insurance. If the borrower’s creditworthiness is unconvincing, residual debt insurance can be a possible way out. In this case, the bank is registered as the policyholder and the borrower is merely the insured person. The bank has full control over the policy. In the event of a payout, the capital is immediately available to the bank. This type of security also allows high-risk borrowers to obtain a loan.