The 47-year-old former midfielder, who captained Bayern Munich to the 2001 Champions League title and earned 35 caps for Germany, is currently a television commentator and received his coaching licence three years ago.
His task will be to make sure Paderborn, relegated from the Bundesliga last season, stay up. They are a point above the second division's relegation zone.
"I had been thinking about working as a coach for some time now and starting at a club like Paderborn is a top address given the impressive careers of my predecessors," he said in a club statement after signing a two-year deal.
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Several of Paderborn's former coaches have gone on to work in the Bundesliga, including Schalke 04's Andre Breitenreiter, Bayer Leverkusen's Roger Schmidt and Borussia Moenchengladbach's Andre Schubert.
The outspoken Effenberg, who twice played for both Bayern and Borussia Moenchengladbach as well as Fiorentina and VfL Wolfsburg, was famously sent home from the 1994 World Cup after showing German fans the middle finger following a sub-par performance in a group game.
"There is chemistry, here," said Paderborn president Wilfried Finke. "Stefan Effenberg is an outstanding expert in football and ready for his work here. He will instil new confidence and will thrill the fans."
Known as much for his leadership and passion as his hot temper -- he is the all-time Bundesliga record holder for yellow cards -- the 'Tiger', as he is nicknamed in Germany, has often made headlines off the pitch, most recently for drunk driving after leaving Munich's Oktoberfest beer festival.
(Reporting by Karolos Grohmann; Editing by Amlan Chakraborty and Martyn Herman)
