How is a Premium Different From a Deductible?

When you shop for insurance, whether it’s medical, homeowner’s, or auto insurance, you’ll hear two different terms thrown around. They both affect how much you pay for insurance, so they are important terms to understand. They are premium and deductible.

What is the Insurance Premium?

The insurance premium is what you pay each month for your insurance. Insurance companies determine your premium based on your risk level. The riskier you are, the higher premiums an insurance will charge you. They base their premiums on your likelihood of filing a claim.

You have to pay your premium each month, or your insurance could lapse. It’s important to choose a policy that has a premium that you can afford. Remember, you will pay the premiums whether you use the insurance or not.

What is the Deductible?

The deductible is the portion of the claim that you will pay before the insurance will take effect. Let’s say you have auto insurance with a deductible of $1,000. You get into a car accident and need to file a claim. The insurance company will require that you pay the first $1,000 of the damages before they will start paying for the damages.

You will find deductibles that range from $100 to several thousand dollars. Typically, insurance companies offer a variety of deductibles to help you choose the program that fits your budget. You should choose your deductible based on what you can afford.

For example, if you have the option of a $1,000 or $2,500 deductible, but you don’t have $2,500 in a liquid account, such as checking or savings, you shouldn’t choose the higher deductible. Even though you don’t need to pay the deductible unless you need to make a claim, there’s no guarantee that you won’t have to use the insurance.

How Deductibles and Premiums are Related

While the premium and deductible are two different things, they do coincide. As we said above, you have a choice on your deductible on most insurance programs. The larger deductible that you choose, the lower the premium an insurance company will charge.

Insurance companies charge the lower premium because they take a lower risk when you have a larger deductible. Going back to the auto insurance example with the $2,500 deductible. If you were in an accident, the likelihood of the insurance company having to pay anything beyond the $2,500 that you are required to pay is small. In exchange for this low risk, the insurance company will give you a lower premium.

Before you choose a premium and deductible, think carefully about what you can afford. The premium is something you will pay on a regular basis, so you should make sure that it fits within your monthly budget. Your deductible is something you will pay should you need to make a claim. You need to decide if you can afford a higher deductible should something happen or if you should take the lower deductible and pay the higher premium instead. The choice is yours and you can always revise your plan should your financial status change, making it easy for you to always stick within your budget.