Having insurance coverage brings peace of mind and is also proof positive that you’re an adult. (Don’t worry, we’ll never tell.)

Like most things worth having, coverage has a cost. Insurance jargon may seem mysterious at first, but if you learn just two terms—premium vs. deductible—you’re on your way to understanding how insurance payments work.

What is an Insurance Premium?

When you buy an insurance policy, you pay an amount called a premium. Depending on the policy, you might pay your premium monthly, semi-annually, or once a year.

What do you get for your green? Help when you need it most. Your insurer promises to pay for any losses you suffer that are detailed in your policy. Let’s say you have an accident in your beloved convertible. Your bad day gets a little brighter when you remember that you’ve been paying your auto premiums and your insurer will pay for the repairs. Yeah, baby! (Make sure that you understand exactly what situations your policy does, and does not, cover.)

Your premium is calculated based on your risk. Your insurer employs underwriters (math whizzes) who delve into your unique situation—your age, where you live, driving record—to predict the likelihood that you’ll suffer a loss. The greater the risk, the higher your premium.

 

What is a Deductible?

When you submit an insurance claim, the deductible is the amount you must pay out of your own pocket before your insurance company kicks in to help. Most insurance policies have a deductible.

Suppose you purchase a homeowner’s policy with a $500 deductible. If lightning strikes your house and causes $2,500 worth of covered damage, you’d pay $500 and your insurer would pony up the remaining $2,000.

Homeowner’s policies generally have deductibles from $500 to $5,000, for example, and auto deductibles are usually $250 to $1,000. Sometimes a deductible is a percentage of the value of the insured property (such as 2 percent) rather than a flat dollar amount. Deductibles vary, but most insurers require a minimum deductible. Choosing a higher deductible will lower your premium payments, but keep in mind that you’ll pay more out of pocket when it comes time to submit a claim.

Essentially, your premium gets you covered, and your deductible comes into play when you have a loss and need to submit a claim. So, it’s best if you know yourself, how you prefer to manage your budget, and your own tolerance for risk. If you’re the kind of person who wants the assurance of being covered and avoid risk, you’ll probably want a lower deductible to avoid unexpected additional expenses. Conversely, if you’re a little more devil-may-care and would rather pay less up front, a higher deductible policy is probably right for you.

Now that you understand the lingo: