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With the price of everyday essentials like gas and groceries rising, Americans will take a little respite from just about anywhere they can get it.
Recently, Dave Ramsey offered up an unexpected way to save on car insurance on his radio show (1) that involves taking on more risk. In response to a listener’s question about whether to lower or increase their car insurance deductible, he suggested raising it in order to pocket the savings they’d earn on their monthly premium.
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He noted that this strategy only makes sense if the decrease in your premium rate is substantial enough that it makes a higher deductible worth it. You could take the money and stash it in a high-yield savings account. If you ever do need to use it, you can withdraw the money.
“We’re always trying to raise deductibles and raise the amount we have in savings to cover it so we’re giving the insurance company less money,” he said.
The math behind Ramsey’s thinking
Let’s play out this scenario with some basic numbers.
Say you pay $300 per month for your car insurance and have a $500 deductible. If you change your policy and take on a $1,000 deductible, but your premium drops to $250, Ramsey’s approach could be worth it.
A $50 per month drop in your premium rate amounts to $600 a year in savings, compared to the extra $500 of risk you agree to take on. This is just one example of how this could work. But generally, if you can make your money back on the added risk within three years, it’s worth it, Ramsey said.
“Take the savings on your premium, divide that into the additional risk, and if that’s about a three, about a three-year risk pattern, you’re probably wise to take the higher deductible in that case,” he said.
A scenario where this doesn’t work, using the same example above, is if your premium only drops by $10 to $290 with a $1,000 deductible. That’s $120 a month in savings. So it would take more than three years for that money to enter your account.
‘Insurance should cover catastrophes, not hangnails’
Ramsey likened taking a higher deductible on your car insurance to doing so with your health plan. You take on upwards of $10,000 in upfront costs for a premium that is way lower than a plan with a lower deductible.
This works out, according to Ramsey, because that amount of debt won’t cause you to go bankrupt on a medical bill. High deductible health plans also tend to be health savings account eligible.
“What causes you to go bankrupt is $350,000 with a NICU stay with a baby or $350,000 with a heart bypass,” he said.
When choosing any insurance plan, you want to make sure you cover the big stuff, Ramsey added. Deductibles are for “little stuff.”
“Insurance should cover catastrophes, not hangnails,” he said. “That’s what you’re looking for.”
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