How does bad wiring cause fire?

There are several ways a fire can start. A loose connection under heavy load can raise resistance, which has the effect of raising the voltage beyond the rating of the wire. Even 4 prong plugs can catch fire because of this. Shorts can also catch fire. Many causes here, but a short is like arc welding and it can be very hot.
Too much load on the circuit can also be a problem, where somebody puts in a circuit breaker rated to more amps than the wire gauge amp rating. Most home wiring is 14 gauge, rated to 15 amps. Some people get tired of tripping the breaker and put in a 20 amp (or larger) breaker. The wire is being asked to carry more power (watts) than it should, which can cause the wire to heat up. If the overload is bad enough, the heat will catch the insulation on fire.
Poor grounding tends to be less of a direct fire issue than a real safety problem. Poor or no grounding can kill by electrocution in cases where your body becomes the best path back to the box or earth. Some people strip a conductor and wrap another wire around it to make a connection. This is just inviting an electrical fire. Connections of wires should be made with wire nuts and twisted together. Loose connections on switches and outlets pose another problem.
When tightening a wire around a terminal screw on a device, bend the stripped wire in a half-moon shape and put the open end towards the right. Tighten the screw in a clockwise motion until tight. This will draw the copper around the screw, thus closing the loop tighter. If you have the open end the other way, the half moon will actually open up a bit, causing the connection to not be as secure. These are all things to avoid with your wiring. Be careful when installing anything to avoid a fire.www.electricalservicesfl.com