(This article has been updated from a previous version.)
When purchasing auto insurance or home insurance, you’ll need to decide how much your deductibles should be. It’s an important decision because this is the amount you may have to pay out-of-pocket if you need to submit a claim.
What is a deductible?
A deductible is the portion of an insurance claim you agree to pay out of pocket in the event of a claim.
Your insurance company picks up the rest. Generally speaking, the higher the deductible you choose, the lower your insurance rate. However, you also don’t want to select a deductible that is beyond what you can afford if you find yourself in an unfortunate situation.
The amount of your deductible will also impact what type of incidents you should make a claim for: If the cost of a claim is around the same price as your deductible, for example, that should discourage you from making the claim.
Related: Taking the stress out of understanding your auto insurance deductible
When taking out a policy, it’s important to look for that sweet spot between affordable but also beneficial to you.
Questions to ask yourself before selecting a deductible
No matter what type of insurance you’re buying, if there’s a deductible to be selected, you should ask yourself a few questions to ensure you’re making the right choice.
1. How healthy is your emergency fund?
If you maintain a healthy emergency fund with a few thousand dollars in it, then a higher deductible might make sense. You can draw on it if you need to make a claim. But if your emergency fund is only a few hundred dollars, then having a $1,000 deductible may exacerbate the stress you’re already experiencing in the event of an incident.
Insurance is designed to support you in times of misfortune. Paying a deductible after submitting a claim shouldn’t cause you to you lose sleep at night.
2. What is the value of the item being insured?
When insurance companies are writing up a policy, they focus heavily on the replacement value of whatever it is they’re covering. The value of the item helps them determine your monthly insurance premium, and it helps you pick the best deductible for yourself.
For example, the value of your car comes into play when your car is older and not worth very much.
Let’s say you’ve got an older vehicle that’s valued at $1,100. Having collision or comprehensive coverage with $500 deductibles means the maximum payout should you need to submit a claim will be $600. Is the coverage worth it given the extra premium you’ll pay? It’s a balancing act and a personal choice but it’s something that needs to be thought out.
In fact, depending on the value of your vehicle you may even decide to drop your collision or comprehensive coverage.
However, doesn’t apply to every scenario. For example, your home is obviously worth more than the typical $1,000 deductible that many homeowners pick for their home insurance policies. However, if you have additional higher-value items in your home, like valuable jewelry or fine art, you should consider taking out a separate insurance rider for those items, which will require its own separate deductible.
Related: Is your jewelry insured?
3. What’s the chance you’ll make a claim?
Some people select lower deductibles, so their out-of-pocket expenses are minimal at the time of a claim. They plan for the worst case "what if" scenario. Others have been fortunate to have never submitted a claim or have rarely needed to, and or they find they have a higher risk tolerance, so they set their deductibles a little higher.
If you can afford a higher deductible (or to just pay for an incident out of pocket without making a claim), you may be able to pay a slightly lower annual premium.
Still unsure? Ask your broker
When you purchase your policy, you won’t be expected to make the deductible decision on your own.
The insurance broker or agent on the other end of the phone when you’re buying your policy will help. But, having thought out these three questions and the possible answers will go a long way in making the decision that best fits your needs and budget.
And no matter what deductible you end up deciding on, you may be able to offset the impact it makes to your premium by comparing insurance rates online and finding the best rate for your needs.
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