An insurance deductible on your insurance policy is the amount that you pay out of your own pocket before your insurance company compensates you for your losses.

For example, if you were in a car accident with damages of $2,000, and your deductible is $500, you would have to pay $500 before your insurance company pays the balance of $1,500.

Deductibles appear on all types of insurance products such as car insurance, home insurance, and health insurance.

What is the purpose of insurance deductibles?

Deductibles are in place to help make insurance more affordable for you as well as for the insurance company. While a deductible places some of the responsibility of paying for expenses and losses on your shoulders, it also allows insurance companies to charge lower monthly fees on insurance. If you don’t make insurance claims often, the savings from lower monthly fees can make up for the cost of any deductible you may have to pay out.

Deductibles also prevent policyholders from making smaller claims that ultimately raise the cost of insurance. If you didn’t have to pay a deductible at all, you may not think twice about submitting insurance claims for minor scratches and dents that appear on your car. Such claims lead to considerable administration and processing costs, which eventually will raise the cost of insurance.

How can you make insurance deductibles work for you?

If you agreed to pay a larger portion of your losses (in other words, a larger deductible), your insurance company will reduce your monthly premium.
Consider this carefully. You must be confident that you will have the funds to cover the amount of your deductible in the event of an accident. It is preferable to pay a higher monthly premium for sufficient coverage than to be without a car for months because you can’t afford to pay your deductible. Remember that the insurance company won’t pay for your losses until you pay your deductible.  Some things to consider:

• The best way to make the most out of a deductible is to save money every month to cover any potential losses. Then you can revisit your insurance policy every year and increase the deductible to match the amount you have saved.
• If you can afford the out-of-pocket expenses of a higher $5,000 deductible, make sure that the difference will actually translate into savings on your premium. Insurance companies typically apply a sliding scale, with the difference between $500 and $1,000 translating into a much larger saving than the difference between $2,000 and $5,000.
• If you have a $1,000 deductible, and your losses are between $1,000 and $2,000, consider carefully if you should submit a claim or not. You may lose a no-claim bonus and become listed as a higher risk, which will translate into higher premiums. So it might be worth paying both the deductible of $1,000 and the remainder if you can afford it.
• On auto insurance policies, the typical deductible is between $500 and $700. Insurers usually do not allow you to drop it below $50. Some auto insurance companies even have a no-deductible option. Your premiums will be higher, but in the event of a loss, there is no deductible to pay.
• Increasing the deductible to $2,000 can sometimes save you around 20% of your premium.
• The deductible is commonly waived in case of theft of the entire vehicle or fire.

Now that you understand what a deductible is and how to use it to lower your monthly premiums, you are in a position to ask your insurer the right questions and make the appropriate calculations.

Editor’s Note: This post was originally published on Wednesday, March 13, 2013 and has been updated for relevancy and accuracy.