Insurance is designed to protect you from life’s curveballs. That’s why it’s important to have the right amount of insurance coverage and to think about your insurance needs before purchasing a policy. Another thing you’ll need to think about is how much you’ll pay for your deductible. The number you choose can impact your bottom line, so you’ll need to pick the right dollar amount.
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What Is a Deductible?
The deductible is the amount you pay out-of-pocket before your insurer will cover any damages or losses associated with a claim. For example, let’s say you wreck your car and you owe $2,500 for the repairs. If your deductible is $500, you’d have to pay that amount in order for your insurance company to pay the $2,000 difference.
Generally, if you have car insurance, homeowners insurance, health insurance or dental insurance you’re expected to meet a certain deductible before the insurance company picks up the rest of the tab. In some cases, your policy may have more than one deductible. With homeowners insurance, for instance, you may pay one deductible for claims relating to damage to the home and another deductible for claims involving damage or loss of personal belongings.
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How Your Deductible Affects Your Premium
Your premium is the amount of money you pay for having an insurance policy. Premiums can be charged monthly, quarterly, biannually or annually, depending on how your insurance plan works. Premiums and deductibles have an inverse relationship. You can think of it as a seesaw: When your deductible increases, your premiums go down. When you lower your deductible, your premiums go up.
Understanding how premiums and deductibles work together is important if you’re trying to decide how much your deductible should be. Essentially, you have to ask yourself whether you should pay a higher deductible and save money until you become seriously ill or pay a lower deductible and shell out more money for premiums.
Going with a higher deductible may seem like a no-brainer. But according to a recent study from the Federal Reserve Board, 46% of Americans said they would struggle to cover a $400 emergency. If you can’t cover an unexpected medical expense, then choosing a higher deductible may be a bad idea.
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Dollar-Amount vs. Percentage-Based Deductibles
With some insurance policies (such as homeowners insurance), your deductible may be a flat dollar amount or a percentage. For example, if you have a $250,000 home with a 1% deductible, you’d pay $2,500. If you have a dollar-amount deductible, you could pay less than that. So which option is better?
If you live in a more expensive home, a percentage-based deductible is probably going to be higher than a dollar-amount deductible. But paying a certain percentage might make sense if you can cover the cost of an emergency using your savings and you don’t want your premiums to rise in the future.
The Takeaway
Before you choose an insurance deductible, it’s best to assess your financial situation. If you don’t have an emergency fund or you spend a lot of time at the doctor’s office, going with a low deductible might be a good idea. Ultimately, however, it all depends on how much cash you can afford to part with if you have to file an insurance claim.
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