Knob and Tube
It utilizes only two conductors per circuit, so that means that there is no grounding conductor, which in and of itself is a reason to tear it out.
There are several reasons that you should have it replaced:
1. It is very old, and consequently brittle.
2. These wires get hotter than modern circuitry, so you can not put insulation in the wall around them. That means you can't insulate your attic floor, or your outside walls. If you do, it is a serious fire hazard.
3. The wires are most certainly overloaded. New houses have an average of 20 to 42 circuits. When the knob and tube was put in, nobody ever envisioned the amount of electrical load you would be putting on them. Back then most homes had four circuits at best.
4. The boxes that used to house the knob and tube wiring, receptacles and lights, are too small. The insulation on the wires will inevitably decay and cause a short circuit.
5. The slightest disturbance of the wiring, such as replacing a light or receptacle, could itself be fire hazard because of the brittleness.
6. The wiring is not color coded, so it is very likely that lights or receptacles are wired backwards.
7. It is a much greater shock hazard than new wiring.
8. This is a big one. Many insurance companies will not cover, or will cancel your homeowners insurance.
9. It really drags down the value of your house, many people will refuse to buy one that contains it.
10. Some electronics rely on a ground wire to operate properly, so you may be putting undue stress on your gadgets.
11. The safety of you and your family is at risk.
The best thing to do, is find a qualified electrician, or contractor, and come up with a plan. Unless you are tearing out all the interior walls to expose the wires, it is pretty involved to replace it with new wiring. It may be easiest to replace one circuit at a time, because it takes a while to complete each section.
The walls can sometimes be "fished", meaning strategically finding ways to get new wires in, with minimal wall damage. It is not cheap, but in the end it looks like it was always there.
The other option it to use Wire-mold surface conduit. Some people do not like it for aesthetic reasons, but it is probably less expensive. Once all of the knob and tube is permanently de-energized, you can insulate your house normally (and safely).
You will sleep better knowing your house wiring is not a ticking time bomb.
The cloth wire without an extra ground wire keeps you from using three prong receptacles, without ground fault protection. There is one thing for sure. These wires are pretty old. They have not been installed in houses for 50+ years. The wiring has a very old rubberized insulation and paper, that is very likely degraded by now.
If you have this kind of wiring, I would have it evaluated by a professional, to determine its integrity, and what you can do to mitigate any fire risk,or whether it needs to be redone.
The second kind of cloth wire has an extra wire called a equipment grounding conductor, or just ground by most people. This wire is a step up from the 2 wire kind. You can use three prong receptacles, and the wire is a bit safer. I would have it evaluated to determine if the insulation is rotting. If you move the wires in a box, and the insulation starts to fall of then something needs to be done. There is a real fire risk. An old house with old wiring requires a skilled evaluation to develop a plan to make ts safer.
It is also possible that the wiring is just fine,and you don't need to update it at all. Chances are though, you may not have enough circuits,and you are tripping breakers. In many cases adding a few new circuits, to take load off of the old ones can really help a lot.
Arc fault breakers can be an inexpensive short term solution to fireproofing old wiring. They will open the circuit faster than a normal breaker should there be a fault. This can be a band-aid until new circuits can be installed to replace the old ones.
Romex - Modern House Wire
What is important to know is that this wiring, when installed correctly, is very reliable, and should last for decades.
Unlike Knob and Tube, or some older cloth wiring, romex always has a ground wire, which makes it inherently safer, both from a fireproofing standpoint, and it is less likely to allow someone to be shocked.
Its outer jacket is slippery and makes installation easy. The only problem is that the cable is relatively soft, and can be damaged by a nail or screw that is driven into the wall. It is important to know that if you see an electrician installing romex that it should be run through the very center of the studs.
It is required to be 1 1/4" inches in from the face of the stud, on both sides. If this is impossible, the a nail guard(steel plate), must be put over the wire to prevent someone from using a nail or screw there.
In all new residential installations Arc Fault Breakers are required in most of the circuits in your house. These breakers will not reset if the wire is damaged, or installed incorrectly. It is a good idea to have them put in existing houses, because they really do help prevent electrical fires.
The good news is that if you see you service panel is filled with romex wires, you can rest assured that the wiring is not that old, and is certainly not rotting.
It is not uncommon to see metallic cables in houses. If you look at your service panel, you can usually see the wiring coming out, unless you panel is recessed.
The older style of metallic cable is called BX cable. BX cable has a steel outer jacket, that is very strong.
These cables did not have a ground wire carried inside them. Instead, the out jacket itself is used as the ground path.
There is good and bad news about this kind of cable. The good news is that it is very tough and if it should short out, it should trip a breaker with only a low chance of starting a fire. The bad news is that the individual wire insulation is not as durable as new insulation. Consequently, due to its age, it is not uncommon to open a box with a light, switch or receptacle and find that when you move the wires the insulation starts to crumble away. If this is the case then the wiring should be updated.
I recommend to homeowners that in the short term, Arc Fault Breakers, should be immediately installed to offer some protection to the circuits. It is not worth risking an electrical fire. Chances are, with a house that old the walls are wood/plaster lathe, and are not as fire proof as newer construction.
Metallic Cable - MC
MC cable is newer than BX. They have a separate ground wire in them, which is a good thing. These cables are tougher than their non-metallic cousins. consequently, they are more resistant to nails or screws, or other incidental contact. You will often see it installed in garages and unfinished basements. non-metallic cables are generally not supposed to be run on surfaces where they are exposed to damage, so MC/AC cables are the preferred method.
The national electric code requires a few things that are different for metallic cables than non-metallic cables. First, the boxes must be metal, and have proper connectors. The boxes must also be bonded(grounded). an MC cables outer jacket is not considered a ground path, so a green screw must bond the ground wire to the box.
An MC cables jacket is considered and proper ground path, so it does not require a bonding screw to the box. It is never acceptable to run a metallic cable to a plastic box. It is however OK to use a metal box with non-metallic wiring.