Credit Rating and Residual Debt Insurance

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The question of the extent to which the creditworthiness of the borrower has an impact on the take out of a residual debt insurance is repeatedly the subject of discussions, i.e. whether consumers with lower creditworthiness are sold residual debt insurance more often than consumers with better creditworthiness. The German Federal Financial Supervisory Authority (bundesanstalt für Finanzdienstleistungsaufsicht, BaFin) has examined this question. There was also a survey of credit institutions in Germany.

Before lending, credit institutions have to check the creditworthiness of the respective borrower. This also applies to installment loans to consumers. As a result of their creditworthiness check, the credit institutions classify the borrowers in different credit ratings or clusters. The number and definition of the credit rating levels used differ considerably from one institution to the next. The number of existing credit ratings ranges from three clusters to 20 clusters.

The conditions for consumer loans are predominantly – if not without exception – based on the creditworthiness of the borrower. 15 of the 30 credit institutions surveyed stated that the level of the interest rate on the loan depends on the borrower’s creditworthiness. The higher the risk of default of a borrower, the more expensive the loan becomes, and consequently the loan interest payable increases with decreasing creditworthiness.

In contrast, there are institutions with a uniform interest rate for all credit clusters. Here, the customer’s creditworthiness has no effect on the interest on the loan. At other credit institutions, however, the price of the consumer loan was based on a combination of creditworthiness and duration or a combination of creditworthiness, duration and loan amount. In this respect, the creditworthiness of the customer is regularly a price-determining factor among several factors. It could not be determined that generally borrowers with a lower creditworthiness are more often sold residual debt insurance than borrowers with a better creditworthiness.

An industry-standard procedure could not be determined after evaluating the answers. The credit institutions handle the issue individually and differently. For some of the credit institutions surveyed, it is the case that more residual debt insurance tends to be taken out when creditworthiness declines, while the rate of residual debt insurance contracts tends to be lower in good creditworthiness. After all, this affects nine of the 30 credit institutions surveyed. At the other credit institutions, on the other hand, based on the closing rates requested, there was no evidence that if the creditworthiness of the borrower fell, more residual debt insurance was sold than for borrowers with a better creditworthiness.

There was also no uniform picture on the question of whether taking out payment protection insurance has an impact on the pricing of the consumer loan. At different credit institutions, the borrowers of a credit rating cluster pay the same amount of interest on their loan, regardless of whether they have taken out residual debt insurance or not. At four banks, the interest rate for loans with residual debt insurance was even higher than for loans without residual debt insurance; This means that loans in the same credit rating with residual debt insurance sometimes even cost significantly more than loans without residual debt insurance. In the case of one institute, however, the figures presented showed that a consumer loan with residual debt insurance was cheaper in terms of the loan interest rate than the loan without residual debt insurance.

The reasons for the different influences of residual debt insurance on the price of the loan remained largely open. This also applies to the remarkable result, according to which the nominal interest rate for loans with residual debt insurance at various banks was higher than for loans without residual debt insurance.

However, one credit institution explains that there was no direct causal connection in this respect. Rather, the interest rate for loans at this institute depends on the creditworthiness. However, the connection rate of residual debt insurance for online contracts is much lower than for contracts concluded in the branch; at the same time, the interest rates for consumer loans concluded online are significantly lower than the interest rates for loans concluded in face-to-face business. The different pricing of consumer loans with and without residual debt insurance for borrowers in a credit rating cluster would only be the result of the different pricing of consumer loans in online business and in face-to-face business. It has not been clarified whether this explanatory model can also be used as the basis for the higher pricing of loans with residual debt insurance found at other banks. However, this shows the great importance a detailed price comparison at several institutes can have for consumers.

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