How a Home Insurance Deductible Works

In this video sketch, you'll learn about the inverse relationship between home insurance deductibles and premiums. You'll also learn how to lower the cost of your policy simply by raising the deductible amount. If you prefer to read the text version of this video, you'll find a complete transcript below.

Transcript follows: Welcome to another video lesson. I'm Brandon, let's jump right in. Today we're going to be talking about homeowners insurance. In particular, I want to talk about the relationship between your home insurance deductible and your premium. Let's start off with a couple of definitions.

A home insurance deductible is the amount you have to pay toward a loss, before your insurance company will cover the rest. A quick example will make this easier to understand:

The Homeowners Deductible in Action

Let's say I have a $1,000 deductible on my home insurance policy. Let's further assume that a tree falls on my house and does $5,000 worth of damage. I have a $1,000 deductible, which means I have to pay the first $1,000 worth of damage caused by the tree. The remaining $4,000 would be paid by my insurance company.

This is how a home insurance deductible works. I have chosen a $1,000 deductible, so I have to pay that much of the damage expense. After I meet my deductible, the insurance company will kick in to cover the remaining expense.

The Insurance Premium

An insurance premium, on the other hand, is just the amount you pay for your insurance.  This is the check you send to your insurance company each year just to have a policy. This cost can also be rolled into your mortgage payment. When this video was made in 2011, the average home insurance premium in the United States was about $650. The cost will vary based on where you live and how much coverage you want.

The Inverse Relationship

There's an inverse relationship between the insurance deductible and the insurance premium. So if you increase the amount of your deductible (the amount you must pay out of pocket toward any losses), it will decrease your insurance premium.

This is something that a lot of personal finance experts recommend. And the reason is because you know you'll be paying your premium. This is just the required cost of coverage. So you'll have to pay this amount each year. But you don't necessarily know if you'll have to pay a deductible. If you have a home insurance policy for ten years, and you don't file any claims against the policy, you will not have to pay any deductibles during that ten-year period. So that is why some people recommend increasing your home insurance deductible to decrease the premium amount.

Strategy: Raising the Deductible

You can decrease your insurance premium by as much as 25% (and sometimes more) just by increasing the deductible by a small amount. For example, a common deductible amount for home insurance is $500. That means you would have to pay the first $500 of a loss before your insurance company would cover the rest. If you were to increase that $500 deductible to $1,000, you could decrease your insurance premium by as much as 25% , and possibly more.

Let's do the math here. In less than five years, the reduced premium would more than make up for the difference between the $500 and $1,000 deductible. So if you went more than four or five years without making a claim, you've already paid for the difference in the higher deductible by lowering your insurance premium.

It sounds complicated, but it's really not. You can raise the home insurance deductible to lower the premium. You will have the option to do this when you shop for a policy. You know you're going to have to pay the premium every year, but you may or may not have to pay any deductibles.

So if you're more concerned with the annual cost of the premium, and you want to lower that amount, then it's probably in your interest to choose a higher deductible.

I hope you've enjoyed this lesson about homeowners insurance deductibles and premiums. If you would like to learn more about this topic, please use the search tool located at the top of this page.