With great homes, comes great responsibility. To ensure that you are financially responsible when buying a new home, you will need to be well-versed in homeowners insurance. For that, we’ve created a home insurance 101 guide to total home insurance. We explain what it is, why you need it, what types of coverages and policies there are, and much more.
Home Insurance 101: What is Homeowners Insurance?
Home insurance, also known as homeowners insurance, is a packaged policy that insures your home, its belongings, and liability associated with your home. Much like car insurance, you will pay an annual premium and have a deductible, which will guarantee you certain coverage in the event of a disaster to or in your home. Covered disasters can range from theft to fires, to different types of storms, depending on your policy.
In short, homeowners insurance is a way to protect you, the homeowner, from heavy financial risks in the face of unexpected costs.
Why Do You Need It?
You need homeowners insurance for the exact same reason you need any other type of insurance: to protect yourself from financial risk. You never know what natural disaster will occur in your neighborhood, nor can you predict the actions of others around you.
The truth is, you may live in the safest neighborhood in the country, but there is always still a risk of burglary, injury, and other natural disasters. Often, the costs associated with repairing these events are far greater than the original market value of your house. When you are investing a large sum of money into buying a house, it is only logical to insure yourself against unpredictable life events, to give yourself financial security.
What Does it Cover?
The coverage in a home insurance policy depends on the insurance company and insurance policy. The most common policies cover certain events, also known as covered perils, such as:
- Fire
- Vandalism
- Theft
- Hurricanes
- Smoke damage
- Windstorms
- Hail
- Damage from the weight of snow, sleet, or ice
- Lighting strikes
- Malicious destruction
- Damage from vehicles
Most standard policies, however, do not cover flood, poor maintenance, or earthquakes. However, since it is equally important to insure your home against flood and earthquake damage, depending on where you live, you can purchase additional external policies for these events. For example, the National Flood Insurance Program sells flood insurance. When it comes to earthquake insurance, checking with your local agent to see how you can get covered, which will help you determine the type of coverage you need.
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Four Types of Home Insurance
Homeowners insurance is divided into four main types of coverage:
- Home Structure
- Personal Property
- Personal Liability Protection
- Additional Living Expenses
Home Structure
This coverage protects the structure of the home or structures that are separate from the house, such as sheds, gazebos, garages, and more. Not all policies will cover these standalone structures, but most policies include them in their coverage. Be sure to check before purchasing a policy that everything you need is covered.
In the event of covered perils, home structure coverage will pay the cost needed to repair or rebuild a home. If included, home structure coverage will pay the cost needed to repair any standalone structures as well. This type of coverage is essential when purchasing any homeowners insurance.
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Personal Property
Policies that include personal property protection insure against the destruction of personal belongings, such as furniture, clothes, and other personal artifacts, in the event of a covered peril.
Standard personal property coverage will cover the homeowner for about 50 to 70 percent of the amount covered on the structure of the home. Personal property coverage also can include off-premises costs. Off-premises coverage ensures your personal property is protected no matter where you are. If you are traveling, and your clothes are affected by a fire, off-premises coverage on your homeowners insurance policy will cover the cost of replacing your clothes.
Personal property coverage tends to be comprehensive in the items covered. For example, expensive luxury items such as furs and jewelry are covered, as are more common items such as trees and plants. With more expensive items, however, there are certain dollar restrictions. Additionally, antiques require extra coverage. When deciding the type of personal property policy is best for you, consider the value of your belongings and what you would like covered in the event of a disaster.
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Personal Liability Protection
Personal liability protection does not cover your home itself or the objects in it. Rather, it covers any bodily injury that the homeowner/policy owner or homeowner’s family members inflict upon others or injuries someone obtains while on your property.
Additionally, it covers property damage caused by the homeowner or homeowner’s family members and pets. Personal liability coverage is not limited to just inside the home. It includes coverage if, through negligence, you are found responsible for bodily injury or property damage. Personal liability protection covers the medical bills associated with treating injury or costs associated with fixing property damage. It will also cover defending the homeowner in court and/or the awards determined by the court case.
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Umbrella Policies
Personal liability protection is important for a homeowner, so you are fully, or at least, mostly covered in case of a lawsuit. To further ensure financial coverage, you can purchase an umbrella policy or an excess liability policy. These policies generally cover $1 million beyond your standard homeowners insurance policy and cost an average of $200-300 more per year. By purchasing umbrella/excess liability coverage, you (the homeowner) are taking on less financial risk.
If you file a liability claim, the amount that you receive depends on the policyholder you are filing the claim against. Conversely, if someone files a claim against you, both the cost you bear and the amount they receive depends on your policy and your policy limits.
Additional Living Expenses
The final type of coverage, additional living expenses, is only needed in conjunction with home structure coverage. Additional living expenses policies cover the costs of living out of the home if you cannot live in your house due to covered perils.
This coverage includes the cost of living at a hotel, daily meals at a restaurant, etc. Typically, the insurance policy will provide a daily amount for you to spend, dependent on your coverage.
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Home Insurance 101: When Do You Buy Homeowners Insurance?
Now that you know you need to buy homeowners insurance, you may be wondering when, in the process of purchasing a home, you will buy the insurance. The answer to this is plain and simple: buy your insurance policy before getting a loan. In order to reach out to mortgage companies to acquire loans for your new home, you will need a homeowners insurance policy. Most mortgage companies require a standard homeowners insurance policy before approving any home loan.
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Different Policies & How Much You Need
As you may have guessed, there are plenty of policies, policy bundles, and different options you can choose from when selecting your homeowners insurance policy. At a minimum, the general home insurance 101 rule of thumb is that your insurance policy should cover your house, personal property, as well as include personal liability protection. If you want comprehensive coverage, your policy should also include additional living expenses and potentially umbrella coverage as extra financial security.
Policy Options
To add to your new home insurance 101 knowledge, the two most popular policy options are the HO-3 Policy and the HO-2 Policy.
HO-3 Policy
This policy is the most popular homeowners insurance policy. It includes the minimum standard coverage, home structure (including separate structures), personal property, personal liability property, and additional living expenses.
Home structure includes all open perils, which simply means that unless a peril is explicitly excluded in your policy, it is covered. Personal property coverage covers the 16 named perils:
- Fire/lightning
- Explosion
- Aircraft
- Vehicles
- Vandalism
- Theft
- Falling Objects
- Windstorm/hail
- Riots
- Smoke
- Accidental discharge/overflow of water or steam
- Weight of ice, snow or sleet
- Sudden and accidental damage from short-circuiting
- Freezing
- Volcanic eruption
- Sudden and accidental tearing, cracking, burning, or bulging
If you are unsure of which policy to buy and don’t just want the cheapest option, but rather comprehensive coverage, the HO-3 policy is a good bet for you.
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HO-2 Policy
The HO-2 Policy is still comprehensive but is a less broad policy option. Similar to the HO-3 Policy, the HO-2 Policy covers all the necessary standard coverage needs, such as home structure, personal property, personal liability, and additional living expenses.
The main difference between the HO-2 and HO-3 policies is that the HO-2 policy only covers named perils, i.e., the 16 named perils above. The HO-2 Policy is a good option for mobile homes, or if you are looking for a comprehensive but cheaper version of the HO-3 coverage
Other Policy Options: HO-1, HO-4, HO-6
There are a variety of other policy options aside from the HO-2 and HO-3 policies. The HO-4 option is a good option if you rent your home, as it covers additional living expenses as well. If you are looking for a bare-bones option, consider the HO-1 policy. It is the most limited policy option, but it still covers the minimum standards of homeowners insurance.
If you live in a condominium or co-op, the HO-6 Policy may be the correct option for you. The HO-6 Policy covers the portion of the home structure owned by the policyholder, not the entire structure. Similar to the HO-2 Policy, it covers the 16 named perils.
As each has its own nuances, it is important to shop around policy types and insurance companies. It may be helpful to either hire an agent to help you determine which option is best for you or to use resources online comparing policies.
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How is Homeowners Insurance Calculated?
Typically, homeowners insurance policies cover up to 125% of the cost to replace, rebuild, or repair the damages. To create a quote for your personal homeowners policy cost, the insurance company will typically use a type of software or algorithm to identify the cost to replace your property in the event of a disaster.
Things to Remember
When you are purchasing homeowners insurance, it is essential to remember that you are not looking to find a policy that replaces the market value of the house. You are looking for a policy that will cover the cost of replacing your house. The valuation of your policy will seem high if you are comparing it to the market value of the house. However, this is not the cost you should be benchmarking your insurance policy to.
Deductibles
Typical to insurance policies, each policy will have a deductible and a premium. A higher deductible will result in a lower annual premium. Premiums can range from $400 to $1500 per year. Choosing the policy that is best for you depends on your ability to pay an out-of-pocket deductible in the event of a disaster.
For a home insurance 101 example, if there is a small fire in your house that costs you $1000 to repair, but your deductible is $2500, you will be expected to cover the cost yourself by your insurance company. If you do not expect to have the amount of your deductible, in this case, $2500, available to you at any given time, it may be better to opt for a policy with a higher annual premium and a lower deductible. That way, your out-of-pocket deductible cost will be lower. As with any insurance plan, there are advantages and disadvantages to a high-deductible plan.
The choice is yours on which is best for you.
Home Insurance 101: How to Get Paid Back
In the event of a disaster or covered peril, you will file a claim to your insurance company. The benefits that you will receive are dependent on three main factors:
- Your deductible
- Your policy limits/coverage
- How you choose to receive your benefits
We’ve already gone over your deductible and policy coverage options, so let’s dive into the third factor here, how you choose to receive your benefits. In homeowners insurance, there are three options for reimbursement:
- Actual Cash Value
- Replacement Cost
- Guaranteed/Extended Replacement Cost
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Actual Cash Value
Actual Cash Value reimbursement, also called ACV, pays the cost of replacing your home and/or possessions, minus a deduction for the depreciation of the value. This policy choice is the cheapest, but you will receive the least amount of money back.
Replacement Cost
Similar to Actual Cash Value reimbursement, Replacement Cost reimbursement covers the cost of replacing your home and possessions, but without the deduction for depreciation. Additionally, it covers the cost of rebuilding or repairing your home and possessions, also without a deduction for depreciation. Replacement Cost reimbursement is a good middle-ground option if you want more coverage, but do not want the most expensive and/or comprehensive policy.
Guaranteed/Extended Replacement Cost
Guaranteed/Extended Replacement Cost reimbursement offers the most coverage, but is the most expensive. This type will reimburse you with whatever the cost to rebuild the home to its original state was, no matter the cost. Guaranteed/Extended Replacement Cost reimbursement can exceed the coverage limits, to a certain extent (usually 20 to 25 percent more than the coverage limits).
This policy protects you in two main ways. One, it protects against increases in construction costs or deviation from original construction cost projections. Two, it protects you against the time taken to rebuild or repair your home. If you are put out of your home for one year instead of two months, you will incur more costs than expected. Guaranteed/Extended Replacement Cost affords you the highest financial security in the face of unexpected events.
Home Insurance 101: What’s Next?
Now that you know what home insurance is, why you need it, what it covers, and how to get it, you’re an expert.
Tell us: Is this your first time buying homeowners insurance? What kind of coverage do you think is best for your needs?
