When you purchased your new car and closed on your home, did you pick your insurance deductibles quickly, giving them little thought?
If so, that haste could cost you. Deductibles are one of the most important parts of any insurance policy. In addition to determining how much money you'll receive when you file a claim, they also affect how much you pay in premiums.
Here's what you need to know to choose insurance deductibles that fit your budget.
What Is a Deductible?
When you experience a loss that's covered by your insurance policy, the deductible is the amount you're responsible for before the insurance pays. Let's say you're in an auto accident and the cost to repair your vehicle is $1,200. If you have a $500 deductible, you're responsible for the first $500 of the repair cost, and your auto insurance company will cover the remaining $700.
"Deductibles share the financial risk of loss between you and the insurance company," says Barri Pool, assistant vice president in USAA P&C underwriting. "The more risk you're willing to take on through a higher deductible, the lower your premium."
Generally speaking, deductibles only apply to property damage, not the liability that kicks in when you're found legally responsible for injuries to other people or damage to their property.
Homeowners Deductibles
A homeowners insurance deductible may be complicated. Here are the types of deductibles you may encounter:
- Percentage deductible. Most of us think of a deductible as a specific dollar amount, but many deductibles on homeowners policies are stated as a percentage of the home's insured value. For example, if your home is insured for $200,000 and your homeowners policy has a 1% deductible, you'd be responsible for $2,000 before insurance benefits begin. If the insured value of your home rises, your deductible will rise with it.
- Split deductible. If you live in a catastrophe-prone area, you may find your homeowners policy has multiple deductibles that differ depending on the peril. For example, you may have one deductible for wind and hail, and another for other risks.
- Flood insurance deductible. Generally, homeowners policies don't cover floods.1 To protect your home against that risk, you should consider purchasing a flood insurance policy.
Auto Insurance Deductibles
Your deductible for auto insurance varies by state, with options up to $1,000 or more, Angela Preciado, USAA auto product management director, explains. The most common amounts for auto deductibles are $250 and $500, she says.
Auto insurance policies usually require you to carry separate deductibles for comprehensive and collision coverages. Comprehensive covers things such as fire, vandalism, glass damage and theft. Collision covers vehicle damage due to an accident, regardless of fault. You pay the deductible that applies to the type of claim that you have, Preciado says.
For instance, if you're at fault in an auto accident and choose to file a claim, you pay the collision deductible amount. If someone vandalizes your car and you file a claim, you pay the comprehensive deductible amount.
"It is possible you could be subject to both deductibles, depending on the type of loss. But this is not common," Preciado says. An example of this type of situation, she says, might be if a thief breaks into your car and then you drive the vehicle, get into an accident and file claims for both losses. The vehicle break-in would be covered under comprehensive, and the accident would be covered under collision.
"Keep in mind, if you are in an auto accident that isn't your fault and the other party has insurance, the damages to your vehicle should be covered under the other party's liability property damage coverage," Preciado says.
When setting your deductible amounts, Preciado suggests:
- Choosing a deductible that you can afford. If you select a $500 deductible, for instance, your emergency fund should have $500 available in case you do have a loss.
- Consider the vehicle's actual cash value when deciding whether or not to pay for comprehensive or collision coverages and choosing how high the accompanying deductibles should be.
Choose Your Deductible Wisely
There's a natural tendency to lean toward a lower deductible. Who wouldn't like their insurance company to pay more at claim time? Carrying a very low deductible, however, can be pricey. Remember, in general, the lower your deductible, the higher your premiums.
"As you contemplate your decision, keep in mind that insurance is designed to protect you from a financial setback, not cover small losses that you can afford to pay," Pool says.
Given the trade-off between deductibles and premiums, you may want to avoid extremes in either direction. If you set the deductible as low as possible, you'll have a higher premium. Set it too high, and you may struggle to cover your share of the cost when something goes wrong.
Pool has a common-sense guideline for this decision: Set your deductible at the highest level you can comfortably afford to pay as an out-of-pocket expense. Having money on hand for unpleasant surprises is exactly what an emergency fund is for. "If you've socked away at least three to six months' worth of living expenses, you may feel more comfortable with a higher deductible on all your insurance policies," she says.
But remember, someone else may have a say in setting your deductibles. "If you've borrowed money to buy your car or home, your lender may require that the deductible not exceed a certain amount," Pool says. In addition, the available minimums may differ by insurance company and state.
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