How Big Should Your Car Insurance Deductible Be? Here's What Dave Ramsey Thinks
- Car insurance policies come with deductibles, the amount that must be paid out-of-pocket before the insurer covers losses.
- Finance expert Dave Ramsey recommends a $1,000 deductible for many people.
- Drivers can do a break-even analysis to see how long it would take for a change in deductible to make sense.
Don't set a car insurance deductible without reading this advice.
Car insurance provides extremely important protection for financial assets. The car insurance policy will determine the extent of losses a driver could face when something goes wrong in a collision, as a result of vandalism, because of theft, or when any other covered loss occurs.
In addition to deciding on the types of car insurance to buy, motorists also must decide how large -- or small -- their deductible should be. A car insurance deductible is the out-of-pocket spending a covered driver must commit to when a covered loss occurs. The driver must pay the deductible and the insurance company covers losses in excess of it. For example, if a motorist chose a $500 deductible and $4,000 in losses occurred, the driver would cover the first $500 and the insurer would pay for the remaining $3,500 of the losses.
Since motorists have a choice regarding how big their deductible should be, it can sometimes be complicated to make the right choice and set it at the right level. To help out with this issue, finance expert Dave Ramsey has some great advice.
Here's how big a deductible should be, according to Ramsey
Ramsey addressed the pros and cons of high and low deductibles on the Ramsey Solutions blog.
"If you choose a high deductible, your insurance company looks at you as a lower risk and will reward you with a lower premium," the blog states. "If you choose a low deductible, your insurance company sees you as a higher risk and will—you guessed it—give you a higher premium."
Ramsey suggested that many people would be smart to set their deductible at $1,000 -- as long as they have an emergency fund with at least this much in it. Saving a $1,000 emergency fund is one of the staples of Ramsey's financial advice and is one of the "baby steps" he recommends people take to get in control of their finances. For those who have accomplished this step and saved $1,000, a deductible of this size would offer more affordable insurance premiums while still ensuring that car accident losses would also be affordable.
"A $1,000 deductible usually means you'll pay a lower premium. And since the first Baby Step is to save up a $1,000 starter emergency fund, you'll have the savings on hand to cover your deductible," Ramsey said.
Should you listen to Dave Ramsey?
Ramsey's suggestion to opt for a larger deductible (that can be covered by emergency savings) makes sense for a lot of people. A lower deductible can raise premiums significantly, and it may not be worth paying higher costs in case of an accident when the resulting loss could easily be paid for.
To make sure that a higher deductible is the right choice, Ramsey also suggests doing a break-even analysis -- and every motorist should take this step. Essentially, this involves assessing how much money could be saved by changing to a higher deductible policy and seeing how long it takes for this savings to cover the difference in the deductible.
Ramsey gives the example of someone who increases their deductible from $500 to $1,000 -- so they would have to pay $500 more if a covered loss occurred. If this move reduced annual premiums by $150, in around 3.5 years, the premiums saved would pay for the added $500 in out-of-pocket costs after a crash or other loss. If no accident occurred in 3.5 years, this extra money could just sit there waiting to cover a future collision while the driver would continue to benefit from the premium savings.
Doing this break-even analysis is a great way to determine if Ramsey's recommended $1,000 deductible makes sense.
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